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Alecto co(pilot 12)

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Alecto co(pilot 12)

  • This topic has 4 replies, 2 voices, and was last updated 5 years ago by John Moffat.
Viewing 5 posts - 1 through 5 (of 5 total)
  • Author
    Posts
  • June 6, 2020 at 12:17 pm #572978
    Sneha00
    Member
    • Topics: 46
    • Replies: 20
    • ☆☆

    In b part the que says- is considering and assuming that the co does not face any basis risk. What does this line mean? What it has to with que.? What will be affected if there is basis risk?

    June 6, 2020 at 2:21 pm #572988
    Sneha00
    Member
    • Topics: 46
    • Replies: 20
    • ☆☆

    Also in the same que, in b part answer, they have written go short in the futures market
    What is short here?
    We do long call and put, so here we should have done long put futures.
    We do short only in collar.
    Please explain what they meant by short?
    Also for clarification please explain diff between short and long.

    June 6, 2020 at 4:22 pm #572992
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    I assume that you have watched my free lectures and that you are therefore happy that we always assume in exam questions that the basis falls linearly to zero over the life of the future. In practice there is no reason why the relationship should be linear and therefore the actual results may be different from the result we predict. This creates an element of risk and it is called the basis risk.

    Going long is buying now and selling later. Going short is selling now and buying later.

    June 6, 2020 at 5:26 pm #572995
    Sneha00
    Member
    • Topics: 46
    • Replies: 20
    • ☆☆

    But in short call and put we receive premium, so here we were buying call option so it should have been long call?

    June 7, 2020 at 10:06 am #573025
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    It is in the futures market that they are going short – they are selling futures now and buying back at the end of the deal so as to hedge against a rise in interest rates. There is no premium involved when dealing in futures.

    As far as the options are concerned in part (a) they are buying a call option (so paying a premium) on futures so as to protect against a rise in interest rates. If they create a collar they will also sell a put option on futures (so receiving a premium) – they reduces the net cost but limits the benefit if interest rates fall.

    Have you watched my free lectures on the management of interest rate risk?

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