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https://www.accaglobal.com/content/dam/acca/global/pdf/p4sgp_2009_dec_q.pdf
https://www.accaglobal.com/content/dam/acca/global/pdf/p4sgp_2009_dec_ans.pdfHi Mr John,
Hope all is well!
I am having a hard time understanding the calculation provided in the answer for question 5 part b) and part C), so basically:
– The vanilla Swap
– The value at risk.I hope my question is clear, I just don’t understand where these numbers came from. Please let me know if you require me to be more specific.
I have almost perfected interest rate questions when it comes to futures and options and I am REALLY hoping it will appear in the exam. However, that question is different than other interest rate questions I answered.
– Just one question related to futures, surprisingly, I found bPP revision kit in some answer saying that futures can be matched EXACTLY with the amount needs to be hedged, unlike options (due to the contract size etc..). I don’t understand, I don’t think this is the case. Futures also have a contract size, the thing with futures is that they COMPLETELY FIX the interest rate and it doesn’t matter whether it rises or fall, it will be fixed, but they still have the limitation of contract size.
(Please correct me if I am wrong as regards the above).
I have studied foreign exchange well and have already practiced “some” questions, but I would like to focus now on interest rate as I hear it is likely to come, as provided on Open tuition too, I hope this is a wise decision as I don’t have enough time to focus on everything! :-/
Many thanks – Apologies for the long query.
Maha
Firstly the 2009 exam was set by the previous examiner and so I would not be too worried about it – he set dreadful papers (which is why he is no longer the examiner!)
However, as far as the swap is concerned, the way it works is that three things will happen. Katmai will borrow at L + 1.20% but since it is payable half yearly they will pay L/2 + 0.6% every six months. Secondly, because of the swap, they will pay 5.40% (or 5.4/2 each half year) and receive Libor (or L/2) each half year.
So the net effect is that they will pay L/2 + 0.6% + 2.7% – L/2 = 3.3% every half year.
To turn this into an annual rate, it is 1.033^2 – 1 = 0.0671 or 6.71%With regard to the VAR. Because we need the six monthly std devn, we need to use the fact that you cannot add std devs, but you need to square them, then add them, then take the square root.
So if S is the six-monthly std deviation, then (S^2)+(S^2) = 1.5^2
S^2 = (1.5^2) / 2
S = 1.061%Finally, I don’t understand BPP’s comment either if you have quoted it correctly. Because of contract size it will be unlikely that you will be able to match exactly 🙂
Well, thank you Mr John for your response and for mentioning this because I have been very much frustrated with some questions! Apologies for my late response, I am so overwhelmed with P4!!
I hope whatever comes on inters rate to be related to futures and options, that would be nice!
Thanks
Hi Mr John,
Sorry further question – Speaking of VAR. When it comes in the context of an investment appraisal question, there is something that I don’t understand.
In Jupiter question (12/08)
The daily standard deviation was $650,000 and we were asked to calculate the 95% daily VAR.
The answer says:
If X= 5% and standard deviation = 650,000
Then the confidence level is 1.65 deviation from the mean.
I am not sure what (x) stands here for. Although this is not my main question, my main question is, where did the 1.65 come from? I think it came from the distribution tables? Yet not sure how.
The calculation seems relatively easy, but I need to clear that up.
Many thanks!
Maha
5% is 100% – 95%
(there is 95% probability of being above the value and therefore 5% probability of being below it)
Because we assume that the distribution is symmetrical, there is 50% probability of being below the average.
So to be between the average and the limit of 5%, is 50% – 5% = 45% (or 0.45).You then look up in the tables to see how many SD’s come out with an answer from the tables of 0.45. You will find that looking up 1.64 gives the nearest to 0.45
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