reverse cash and carry (2008 exam Q6)

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gregorynep

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Sorry, if this has been covered already.. if so, please direct me to the thread.
The calculation in the answer key for the profit in the reverse cash and carry problem seems to be incorrect, at least contrary to the calculation in the book.
specifically, the answer key shorts the spot commodity, whereas the book (example in volume p. 182) shorts the e^(-lease rate/t)
following the f=s*e^(r-lease rate)t formula, i get 2.21 instead of the 2.19 answer in the key. Am I missing something here?
 
also why would we go and buy zero coupon bond.
In level 2, we just had to go long underpriced and short overpriced.
 
mean to say books shorts e^(-lease rate/t) units of the commodity
 
I had the same question…any help would be greatly appreciated
 
Reverse cash and carry means short spot and go long the synthetic which is a combination of the futures and a zero coupon and your shorting costs.
So:
Sell spot at 316 and take the proceeds and invest it at 5% (3 months) = 319.97
Lease the commodity (316) @ 6% (3 months)= 4.78
At the end of the 3 months buy the commodity @ 313
+319.97 - 4.78 - 313 = +2.19 profit.
The bond is because you are taking your short proceeds and investing them to offset the leasing cost.
 
I would give alot to not see any commodity stuff on the exam. this stuff kills, me. Just can’t get a handle on it.
 
sebrock Wrote:
——————————————————-
> Reverse cash and carry means short spot and go
> long the synthetic which is a combination of the
> futures and a zero coupon and your shorting
> costs.
>
> So:
>
> Sell spot at 316 and take the proceeds and invest
> it at 5% (3 months) = 319.97
> Lease the commodity (316) @ 6% (3 months)= 4.78
> At the end of the 3 months buy the commodity @
> 313
>
> +319.97 - 4.78 - 313 = +2.19 profit.
>
> The bond is because you are taking your short
> proceeds and investing them to offset the leasing
> cost.
I understand the logic, however, the CFA text seems to go about it a different way…it states that:
1: Go long a 3 month forward = St - 313
2: Go short the spot value of the commodity discounted at the lease rate = 311.30
a: In three month pay out St
3: Take the proceeds from the short position and invest at 5% for three months = 315.21
Profit = 315.21 - 313 = 2.21
I am just trying to wrap my head around the disparity between the two methods.
best,
TheChad
 
Do it my way, it’s more intuitive.
All you are doing is selling the commodity short, paying the short cost (lease rate), investing the short amount in a zero coupon (this is where your collateral return comes from in the futures equation) and then buying the commodity forward at the forward price.
If you do a cash and carry then you buy the spot and finance it by selling a zero coupon bond, leasing out the commodity and then selling at the forward rate.
If you understand the mechanics, it’s really quite easy. Your step #2 just combines my step 2 and 3 but if you do all the steps it’s easier to understand. But in the end their steps are this then:
1. Sell spot short + 316
2. Pay PV of lease rate to be allowed to short commodity -4.78
3. Invest the remaining in a zero coupon bond 311.22 @ 5% for 3 Months = + 3.91
4. Buy the commodity forward 3 months later @ 313
Add them all up. 316 - 4.78 + 3.92 - 313 approx 2.19, closer to 2.14 - but if you look at the exam answer, they do it my way and use my numbers.
 
sebrock Wrote:
——————————————————-
> 2. Pay PV of lease rate to be allowed to short
> commodity -4.78
Shall it be : Pay FUTURE VALUE of lease rate to be allowed to short commodity -4.78 ?
All the values shall be the VALUEs at the end of the 3 months, right ?
 
AMC Wrote:
——————————————————-
> sebrock Wrote:
> ————————————————–
> —–
> > 2. Pay PV of lease rate to be allowed to short
> > commodity -4.78
>
> Shall it be : Pay FUTURE VALUE of lease rate to be
> allowed to short commodity -4.78 ?
>
> All the values shall be the VALUEs at the end of
> the 3 months, right ?
Yes, those are future values. I was just reconciling what I think is the easier way to do it and how Chad did it. But yes, that is what you pay at the end of 3 months.
 
sebrock Wrote:
——————————————————-
> Do it my way, it’s more intuitive.
>
> All you are doing is selling the commodity short,
> paying the short cost (lease rate), investing the
> short amount in a zero coupon (this is where your
> collateral return comes from in the futures
> equation) and then buying the commodity forward at
> the forward price.
>
> If you do a cash and carry then you buy the spot
> and finance it by selling a zero coupon bond,
> leasing out the commodity and then selling at the
> forward rate.
>
> If you understand the mechanics, it’s really quite
> easy. Your step #2 just combines my step 2 and 3
> but if you do all the steps it’s easier to
> understand. But in the end their steps are this
> then:
>
> 1. Sell spot short + 316
> 2. Pay PV of lease rate to be allowed to short
> commodity -4.78
> 3. Invest the remaining in a zero coupon bond
> 311.22 @ 5% for 3 Months = + 3.91
> 4. Buy the commodity forward 3 months later @ 313
>
> Add them all up. 316 - 4.78 + 3.92 - 313 approx
> 2.19, closer to 2.14 - but if you look at the exam
> answer, they do it my way and use my numbers.
I agree that your way makes more sense…I am just struggling with the difference between it and the method that CFAI provides.
Thanks for your clarification on this…I am hoping that I will not have to deal with this on test day.
Best,
TheChad
 
sorry to bring up this again, but isn’t 2.21 and 2.19 just the difference of rounding?
 
You need to include the bit about going long the futures contract when you short the spot. Otherwise you are still exposed to the market.
 
looked at the book again, vol5 page 181-182, it seems the tables were wrong??
the 2008 exam logic is actually very solid
 
so guys, which method are we supposed to follow?
the one shorting the spot discounted @lease rate or the other?
by the way, there was a similar question in BSAS2010 but for a cash & carry, they proceeded as within CFAI 2008 key answer and not as described within CFAI books..
am reallay confused guys:(
 
Bumping this blast from the past… yes i know i have become obsessed with these stupid problems but i want to get it nailed down so i can move on.
I used the OP’s method of the no arb model minus the forward and got 2.21 vs 2.19…. has this been resolved elsewhere that i missed in searching?
Thx
 
there was a post from doubts and ftwcfa a couple of days ago.
Doubts had apparently written to the CFAI - and asked this same question. They stated that using either method 2.21 or 2.19 would get credit.
please search for the post in the last couple of days.
 
I always attempt to search, sometimes I miss them. Thanks. Shit come to think of it I may have even responded to that thread.
 
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