Title Derivatives.pdf ✅

Last Revised: 08/14/2023 1 2024 Level 2 - Derivatives This document should be used in conjunction with the corresponding learning modules in the 2024 Level 2 CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures are copyright 2023, CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved. Required disclaimer: CFA Institute does not endorse, promote, or warrant accuracy or quality of the products or services offered by MarkMeldrum.com. CFA Institute, CFA®, and Chartered Financial Analyst® are trademarks owned by CFA Institute. © 2533695 Ontario Limited d/b/a MarkMeldrum.com. All rights reserved. Learning Modules Page Pricing and Valuation of Forward Commitments 2 Valuation of Contingent Claims 20 Review 44 M.M134813896.
Last Revised: 08/14/2023 2 Pricing and Valuation of Forward Commitments a. describe the carry arbitrage model without underlying cashflows and with underlying cashflows b. describe how equity forwards and futures are priced, and calculate and interpret their no-arbitrage value c. describe how interest rate forwards and futures are priced, and calculate and interpret their no-arbitrage value d. describe how fixed-income forwards and futures are priced, and calculate and interpret their no-arbitrage value e. describe how interest rate swaps are priced, and calculate and interpret their no- arbitrage value f. describe how currency swaps are priced, and calculate and interpret their no- arbitrage value g. describe how equity swaps are priced, and calculate and interpret their no- arbitrage value LOSs will match between the video and the MM PDFs, but may be in a different order than the CFAI readings M.M134813896.
Last Revised: 08/14/2023 3 Forwards/Futures Prices ⇒ Arbitrage-free pricing & valuation assumptions/ replicating instruments are identifiable and investable market frictions are nil short selling is allowed with full use of proceeds borrowing & lending are available at a known risk- free rate Notation: S – underlying F – forward V – value of forward f – futures v – value of futures V0 = 0 - at contract initiation, the value of a futures/forward contract = 0 (i.e. no money changes hands) - at expiration, FT = fT = ST (called convergence) VT = FT – F0 = ST – F0 (long) VT = F0 - FT = F0 – ST (short) - futures/ vt = ft – ft-1 (before) vt = 0 (after) 1/ no underlying cash flows F0 = S0erT - cont. comp. or/ F0 = S0(1 + r)T - periodic comp. e.g./ S0 = 100 rf = 5% T = 1 yr. F0 = S0erT = 100e.05(1) = 105.127 F0 = S0(1 + r)T = 100(1.05)1 = 105 Step #1. Borrow $100 for one year Step #2. Buy S0 Step #3. Sell F0 Step #4. Payback loan of S0erT at time T Page 1 LOS a, b - describe - compare - calculate - interpret Page 2 LOS a, b - describe - compare - calculate - interpret futures are marked- to-market daily M.M134813896.
Last Revised: 08/14/2023 4 e.g./ S0 = 100 rf = 5% T = 1 yr. general rule : buy low, sell high Case 1: F0 = 110 Case 2: F0 = 90 - sell F0 (i.e. short) - borrow $100, buy S0 - at T, deliver S0 for $110 - pay back $105 - at time 0, borrow 5/1.05 = 4.762 (get paid today) - Sell S0 for $100, invest @ 5% - Buy F0 (i.e. long) - at T, take delivery of S for $90, cover short position - profit = $15 - at time 0, borrow 15/1.05 = 14.286 (get paid today) An Australian stock paying no dividends is trading in Australian dollars for A$63.31, and the annual Australian interest rate is 2.75% with annual compounding. Based on the current stock price and the no-arbitrage approach, what is the equilibrium three-month forward price? S0 = 63.31 F0 = S0(1 + r)T rf = 2.75% = 63.31(1.0275).25 = 63.74 T = .25 If the interest rate immediately falls 50 bps to 2.25%, the three-month forward price will: ↓ 63.31(1.0225).25 = 63.66 carry arbitrage reverse carry arbitrage F0 = S0erT = 100e.05(1) = 105.127 or/ F0 = S0(1 + r)T = 100(1.05)1 = 105 Page 3 LOS a, b - describe - compare - calculate - interpret Page 4 LOS a, b - describe - compare - calculate - interpret M.M134813896.