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Dear Sir
This question appeared in Q1 of Sep 18 AFM exam. I did not understand this part and the end of year 1 part
looking at the answers provided by ACCA i was wrong in assuming that the discount factor was 1 for year 0 and 1. Please explain
Regards
Estimates the net present value of the Airone project in Japanese Yen, based on the end of year one being the start of the project (year 0);
Always, Tim 0, time 1 etc. are points in time that are one year apart. Strictly the examiner is wrong to refer to them at ‘year 0’ etc., but he always does. However, again, they are always points in time that are 1 year apart – this is the whole reason for discounting as we awls do.
I understand that, but what does he mean by , “based on the end of year one being the start of the project (year 0);”?
Does that mean we discount differently? I am used to year or Time 0 being a df of 1 and so on, because looking at the answer the examiner did the normal discounting
That is why i failed. i was borderline and the confusion caused me to use the Discount factor of 1 twice to achieve the end of year 1
By year 0 it means time 0 and the discount factor is 1.
Although you may find it confusing, the way the question is set out makes it clear that what is referred to as Year 1 is 1 year later and therefore the flows needs discounting for 1 year.
Yes there is – time 0 is (as always) the date of the initial investment.
Sir,also as a follow up question regarding Sep 18 Q1,where we have to estimate amount of JPY receivable using futures,looking at the Examiner’s answer,the portion of the basis risk is added to the spot future’s price then used to calculate the total receivable,the predicted future’s price is different when i take lectures approach where i convert at spot using forward rate and adding the profit portion of the future resulting in a different receivable because my predicted future’s price is different or am i confusing different concepts ?
In the lectures, I never convert at spot using the forward rate and then take the profit/loss on the futures. We convert at whatever the spot is on the date of the transaction (which is not the same as the forward rate).
However, as is usually now the case in the exam, we do not know the spot rate on the date of the transaction and therefore have to use the lock-in rate.
The examiner has calculated the lock-in rate in two ways – it is shown in the answer under the heading ‘predicted futures rate’. The way I explain in the lectures of calculating the lock-in rate is the method he has shown in brackets – I think that it the better way, but it doesn’t matter which of the two ways shown you use because they both obviously give the same result.
Thanks a lot Sir, i was confusing the spot on the date of the transaction with forward rate,it is clear now
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