Two concept questions remember, creating, position, against, reading

NakedPuts

1. I remember reading somewhere in the curriculum that equity is a good hedge against inflation, but there was some kind of qualifier. Anyone remember what the qualifier/exception is?

2. When we create synthetic equity (or cash) using futures, we use the formula
(Tbill Value)(1+rf)^t / Pf. The other alternative is to alter the beta of the portfolio using
(bT - bp)/bf x (Vp/Pf). If we use the second formula, is this technically still creating a synthetic position? I know you can achieve the same result but I am not sure if this is still called creating synthetic cash/equity.

skycfa

1. As long as inflation is not too high and the companies can pass on the price hike to consumers, equity can be a good hedge against inflation.

2. I believe it would still be called synthtic casg/equity.

pennyless

1. Equity will be a good hedge against inflation for as long as the company is able to pass cost inflation along to customers.

2. Why would you want to hold cash (plain vanilla cash) when you can invest it at the risk free rate? By using the second formula, you end up with plain old cash but the first formula converts the cash into a risk free rate investment. That is why when you need to change equity exposure to cash over a certain period of time you use the first formula that converts to cash at risk free rate but to change exposure to another asset class you use the first formula since you need to get plain cash before re-investing.

thommo77

2nd one would be synthetic cash as well. You are short the futures . Your assumption is that the full notional value of the trade is invested in T-Bills and earns a risk free rate. This assumption should be true in any futures trade

lcai

janakisri Wrote:
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> 2nd one would be synthetic cash as well. You are
> short the futures . Your assumption is that the
> full notional value of the trade is invested in
> T-Bills and earns a risk free rate. This
> assumption should be true in any futures trade


By using the second formula, the number of futures you will buy will be smaller than the number of futures you will buy by using the first formula. The difference is the risk free rate. Try it. Do the calculation.

Colum

pimpineasy Wrote:
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> storable energy commodities and to a lesser extent
> precious metal are most effective inflation hedges
> while agriculture/livestock are not effective
> inflation hedges


right but that doesnt explain how equities can sometimes fail to be inflation hedges

liangfeng

elcfa Wrote:
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> Both formulas are used to create synthetic cash.
> Both should yield similar number of futures to be
> bought, if used/calculated correctly.
> They use different inputs, however.

Is it that (Tbill Value)(1+rf)^t / Pf is used when cash/synthetic cash is involved ? and (bT - bp)/bf x (Vp/Pf) is used when cash/synthetic cash is not involved ? Thanks in advance !

PalacioHill

No
Both are used to 'convert' a stock portfolio temporarily to a (synthetic or virtual) cash portfolio (thus earning RF instead of stock return) by shorting same number of futures.


You have a portfolio with beta = 1 and instead of selling it out for, say, 4 months before buying it back in again because you don't like the volatility of the next 4 months, you use this strategy to get synthetic cash for the next 4 months.

You use either of the formulae (see below) to calculate the number of futures required depending on what input you have from the exam text. The result should give the same number of futures.

1. (Mkt value of portfolio/Pf) * (1+RF)^t
2. (Mkt value of portfolio/Pf) /(index beta) (here assuming that portfolio beta = 1)



Edited 1 time(s). Last edit at Wednesday, May 11, 2011 at 05:18AM by elcfa.

aidebaobao

elcfa,

What I meant are :

(Tbill Value)(1+rf)^t / Pf is used when the stock index is converted to cash or the cash on hand is converted to stock index temporarily for a short period (e.g., a few month) for whatever the reason.

While (bT - bp)/bf x (Vp/Pf) is used purely for beta adjustment ?

No ?

mik82

elcfa,

OK, Thanks so much !