R51 Q4: is answer wrong?

CFA Level II Derivatives
#1

Hi, quick q.

Are Practice Problem Q4 D and E (CFAI materials) answers wrong? Because the total gain from the transaction shouldn’t be different that the forward’s final P&L given that the investor never held the asset (was only planning to buy it in 1 year)?

Question 4 reads"A security is currently worth $225. An investor plans to purchase this asset in one year and is concerned that the price may have risen by then. To hedge this risk, the investor enters into a forward contract to buy the asset in one year"

Literal D reads: " Suppose that at expiration, the price of the asset is $190. Calculate the value of the forward contract at expiration. Also indicate the overall gain or loss to the investor on the whole transaction". Literal E is the same with price at expiry of $240.

Thanks in advance!!!

#2

For convenience, the answer to D is:

"Loss to long position = −$45.69

Gain on asset = $35.00 (based on $225 − $190)

Net loss = −$10.69"

Am i missing something very obvious?

#3

anyone? :slight_smile:

#4

Hello - i just ran through the numbers and i would have choosen a loss of 45.69. I am hoping this is an error and not something you and I are missing.

#5

Looks right. U are wrong

#6

Your 2 alternatives a year ago were

  1. enter forward and lose $45.69

  2. buy asset and lose $35

So in choosing forward over buying the asset, you lose $10.69

Same with E

  1. enter forward and gain $4.31

  2. buy asset and gain $15

So in choosing forward over buying the asset, you lose $10.69

That $10.69 is time value of money and will be the same regardless of where the rate falls in a year, but you will be hedged from price risk.

#7

thank you very much for your thorough answer. I understand where you are coming from, but conceptually it doesn’t make sense to me that you are recognizing a gain/loss in an asset that you never held. If you did that in real life you’d be fired or jailed (or both) :slight_smile:

appreciate it