Mismatched FX swap

CFA Level III Derivatives
#1

A quick question regarding mismatched FX swap.
Why in this example, they use bid price for closing the contract and use offer price for opening another contract?
Should we use the offer price for both legs?
@S2000magician or anyone (pls, many thanks)

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#2

Where did you get this question? The answer is wrong for several reasons:

  1. The net cash flow today depends on the amount hedged one month ago, the forward rate one month ago, and the spot rate today. It has nothing to do with the forward rate today.

  2. Because the hedge is being increased, the rate used in the spot market transaction and the new forward transaction will be based on a net sale of USD or a net purchase of EUR; both will use the USD/EUR ask rate.

  3. The exchange rate is stupid: the current exchange rate is about USD 1.20 = EUR 1.00, not USD 0.90 = EUR 1.00.

I hate this junk.

#3

It is in CFAI Q bank

Suppose the exchange rate is correct in whatever manner.

We should buy USD2,500,000 * 0.8876 = EUR2,219,000
and sell USD2,650,000 * 0.8901 = EUR2,358,765

The net cash flow = EUR139,765.
Is it correct?

Many thanks.

#4

The cash flow today comprises two transactions:

  1. Buy USD 2,500,000 in the spot market

  2. Deliver USD 2,500,000 against the expiring forward contract.

The exchange rate for the delivery is the forward rate from one month ago: USD/EUR 0.8913 + 30/10,000 = USD/EUR 0.8943 = EUR/USD 1.1181. When you deliver USD 2,500,000, you’ll receive EUR 2,795,483.

Because the net transaction on rolling over the forward contract is a sale of USD (USD 2,650,000 sold forward > USD 2,500,000 purchased), the spot rate and the forward rate will be treated as a USD sale or a EUR purchase: use the USD/EUR offer rate of USD/EUR 0.8876 = EUR/USD 1.1266. When you buy USD 2,500,000 in the spot market, you’ll pay EUR 2,816,584.

The net cash flow will be EUR 2,795,483 − EUR 2,816,584 = EUR −21,101; i.e., you’ll pay EUR 21,101.

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#5

Shouldn’t the original forward rate from one month ago be: 0.8914 + (30/10,000) = 0.8944 USD/EUR? Getting to the same answer but not following your logic of taking the spot bid and adding points from the offer side.

#6

Good catch. I’ll claim that it was a typo on my part.

1 Like
#7

Looks it is not corrected in the 2023 curriculum as well. This is Q34 in the Practice Problems of Reading 10. I am 100% with @S2000magician on the logic of this.