Hi Sir,
Regarding question 2 on 2011 June part a (Casasophia co), I would like to know why do we convert the forward rate when calculating the underhedge for the options. Before converting forward rate, it is USD 110,000 and 162,500 for exercise price 1.36 and 1.38. Why do we use forward rate to convert?
regarding part b of the question, when calculating the inflation rate for Casasophia and Mazabian:
Mazabian: 9.7% * 1/2= 4.85%
Casasophia: 1.2% * 1/2=0.6%
I don't understand how do we get the 1/2? Could you please explain?
And regarding part c of the question, when calculating forward rates, we use the PPP theory :
So * [1+IA/1+IB]= 128 * [1.0485/1.006]
I don't quite understand why do we have to take the rate 128 MShs. In the question, it is stated that mazabia has offered casasophia to swap the annual income of MShs 1.5bil in each of the next 3 years for Euros at the estimated annual MShs/Euros forward rates based on the current government base rates.Does it mean that Casasophia is required to offer Mazabia euros? I don't really understand how does swap work in this question.
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Options, Swap (2011 June Q2)
12y ago#11. When using the options, we know in advance how much will not be hedged (because of the fixed size contracts). If we do nothing else then that amount remains at risk, because that amount would have to be converted at whatever the spot rate happens to be in 4 months time.. A way of removing that risk will be to use the forward rate, which then fixed the exchange rate on this amount not covered by the options.
2. It is because the inflation rates given at yearly inflation rates. However we need it in six months time (i.e. in half a year)
3. The bank has offered to covert the income in MShs to Euros at fixed rates (instead of us having to convert at whatever the actual spot rate happens to be). The way they are fixing the rates is by calculating a forward rate (using interest rate parity formula). If we agree to this, then we will know exactly how many Euros we will receive. (If we don't agree to it, then the Euro receipt could be higher or lower depending on what actually happens to the spot rates.)
Sir,
Thank you so much for your replies!! I have understood It now! :)
12y ago#3You are welcome :-)
Hi sir,
I would like to clarify the forward and spot rates here. When we are calculating the premium for the options, we convert the premium in USD to euros by spot rate of 1.3585. Is it because we need to pay premium in USD that is why we use 1.3585 instead of 1.3618?
About calculating the underhedge, we convert USD to euros by using forward rate of 1.3623. Is it because we still hv to convert the left over under hedged to euros
I'm a little confused by the buy/sell. Could you please provide some guidance? :/
Thank you.
12y ago#5With regard to the premium, because we are in EUR and the premium is calculated in $'s, we need to buy $'s to be able to pay it. Since it is a $/EUR quote, if we are buying $'s (the first mentioned currency) then it is the lower rate that applies (1.3585).
(If choosing the rate is causing the problem, then do watch my free lecture where I explain why and when each of the two rates is applicable).
With regard to the under-hedge, the point is that the options are in fixed sized contracts, and so we cannot deal in the exact amount of the transaction (which is what we would really want to do). Because of this, we know from the very start that there is a bit left over.
Either we do nothing about this, and that little bit is just left at risk. Or, if we want to remove the risk then we can used forward rates just on that bit (assuming in general that forward rates are available). It is not something to be too worried about, but it is a good point to be able to make in the exam.
Alright. Thank you very much :)
12y ago#7You are welcome :-)
11y ago#8sir, would you please explain me part A currency futures in detail, im not getting it. thank you.
11y ago#9Have you read my previous replies in this thread, because in them I have explained almost all of the answer to part (a).
Hi sir,
Regarding part b, why when we calculate Npv for year 3 we don't need to use exchange rate 120.87 to convert the MShs 1500? Since it is a Forex swap I would say, is it?
10y ago#11I don't understand you, because in part b we are not required to calculate an NPV.
Part b asks what loan finance will be required to undertake the project in 6 months.
Am so sorry, part c should be?
10y ago#13I don't understand where you are getting 120.87 from.
The question says that the swap will be at the estimated forward rates, and so the rates need to be calculated using the interest rate parity formula for 0.5 years, 1.5 years, 2.5 years, and 3.5 years.
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