CFA Reading #29: Risk Management Applications of Forward and Futures

[Stocasto]

Hi there,
I am going over this section on Schweiser and I am getting confused by the fact that some of the formulas used to determine the number of contracts to use are based on the current market value of the portfolio (for instance, the formula used for a synthetic equity index in LOS 29.b), while others are based on the future value of the portfolio compounded at the risk-free rate (for instance, the formula used to alter the duration of the portfolio in LOS 29.d). Besides for this difference, the formulas are conceptually identical. I don’t quite understand the reason for this difference, could somebody please explain?
Thanks

 

[S2000magician]

I wrote a series of artilces that may help you: http://financialexamhelp123.com/level-iii-risk-management-applications-o....

 

[Stocasto]

That does not help

 

[S2000magician]

Stocasto wrote:That does not help

Did you read the article on the synthetics? http://financialexamhelp123.com/the-synthetics-cash-equity-and-fixed-inc...
You grow the number by the risk-free rate if you’re starting with cash or ending with cash; otherwise, you use the present value.

 

[Stocasto]

I understand when to apply one formula versus the other. What I do not understand is the reason for the difference. If the formulas are essentially doing the same thing (modifying the beta or duration of a position), why do we use future value when cash is involved, and present value when it is not?
Thanks

 

[S2000magician]

Cash, unlike equity and fixed income, is assumed always to grow at the risk-free rate. If you start with cash in a forward/futures contract, the amount you’ll have to spend when the contract expires is the future value of the cash. If you’re creating synthetic cash with a forward/futures contract, then the cash you create has to behave like real cash, and the ending value has to have grown at the risk-free rate.