4、Walter Speckley Case Scenario

Walter Speckley is a high-net-worth individual who has recently relocated permanently from Europe to the United States. Speckley has sold his European properties and will receive

Question 1

Based on the information in Exhibits 1 and 2, the price of a 360-day euro forward contract should be closest to:

A. $1.238.

B. $1.244.

C. $1.250.

D. $1.256.

Correct answer = B

"Forward Markets and Contracts," Don M. Chance
2008 Modular Level II, Vol. 6, pp. 38-43
Study Session 16-62-C
calculate and interpret the price and the value of 1) a forward contract on a fixed income security, 2) a forward rate agreement (FRA), and 3) a forward contract on a currency
The formula for the forward currency price is:

F(0,T) = [ S₀ / ( 1 + r_f )^T ] * ( 1 + r )^T

where F(0,T) is the forward price at time "0" for a delivery date at time "T" (which is one year, or "1," in this case), S₀ is the spot exchange rate, r_f is the foreign (European) interest rate, and "r" is the domestic interest rate. Substituting in the information from Exhibit 2:

F(0,T) = ( 1.25 / 1.035 ) x ( 1.030) = 1.244

Question 2

Based on the information in Exhibits 1 and 2, the price of a 360-day forward contract on FBK stock should be closest to:

A. $97.93.

B. $98.07.

C. $103.00.

D. $108.07.

Correct answer = A

"Forward Markets and Contracts," Don M. Chance
2008 Modular Level II, Vol. 6, pp. 26-30
Study Session 16-62-b
calculate and interpret the price and the value of an equity forward contract, assuming dividends are paid either discretely or continuously
The price formula for a forward contract on an equity security is:
F(0,T) = [ S₀ - PV(D,0,T) ] x ( 1 + r )^T
          = [ S₀ x ( 1 + r )^T ] - FV(D,0,T)
where S₀ is the current price of the equity, PV(D,0,T) is the present value of the dividend stream across the life of the forward contract ("T"), while FV(0,D,T) is the future value of the dividend stream across the life of the contract. Given the information in the problem and in Exhibits 1 and 2, the contract is for one-year (T = 1) and the dividend occurs in 180 days (1/2 year). Substituting this into the formula:
F(0,T) = [ 100 - { 5 / ( 1 + 0.03 )^0.5 } ] x ( 1 + 0.03 )
= [ 100 x ( 1 + 0.03 ) ] - [ 5 x ( 1 + 0.03 )^0.5 ]
= $97.93 

Question 3

Dunn’s suggested strategy for using currency futures contracts is unlikely to have any advantage over using a forward currency contract because the currency futures contract will:

A. reflect normal contango.

B. reflect normal backwardation.

C. buy an equal number of dollars.

D. indicate the presence of risk premia.

Correct answer = C

"Futures Markets and Contracts," Don M. Chance
2008 Modular Level II, Vol. 6, p. 82
Study Session 16-63-c
explain how forward and futures prices differ
The pricing formulae for currency forward contracts and currency futures contracts are identical: arbitrage will force the price of currency futures contracts and forward contracts to equality. 

Question 4

Dunn’s explanation of the difference between the 360-day forward exchange rate and the current spot exchange rate is:

A. correct.

B. incorrect, because it ignores future movements in the spot exchange rate.

C. incorrect, because it ignores the fact that the 180-day U.S. yield is higher than the comparable Euribor.

D. incorrect, because the forward exchange rate will be higher when U.S. interest rates are lower than European interest rates.

Correct answer = A

"Forward Markets and Contracts," Don M. Chance
2008 Modular Level II, Vol. 6, pp. 38-43
Study Session 16-62-c
calculate and interpret the price and the value of 1) a forward contract on a fixed income security, 2) a forward rate agreement (FRA), and 3) a forward contract on a currency
The exchange rate quote convention is the price of 1 Euro in U.S. dollars, and because the exchange rate on forward currency contracts is determined by:
F₀(T) = [ S₀ / ( 1 + r_f )^T ] x ( 1 + r )^T
where F₀(T) is the current price of the forward contract expiring at time "T," S₀ is the current spot exchange rate, r_f is the foreign (European) interest rate, and r is the domestic interest rate. (The term of both interest rates is one year, in this example.) When U.S. ("domestic," in this case) interest rates are lower than foreign (European) interest rates, the forward exchange rate will be lower than the spot exchange rate. 

Question 5

In 360 days when the forward contracts mature, the market value of the euro forward contract is $149,000 and the market value of the forward contract on FBK is $263,000. The credit risk from Speckley's perspective is:

A. Answer A.

B. Answer B.

C. Answer C.

D. Answer D.

Correct answer = B

"Forward Markets and Contracts," Don M. Chance
2008 Modular Level II, Vol. 6, pp. 44-45
Study Session 16-62-d
evaluate credit risk in a forward contract, and explain how market value is a measure of the credit risk to a party in a forward contract
Speckley is short the Euro forward with no credit risk given that the market value of the forward is positive. The long counterparty stands to lose $149,000 if Speckley defaults. Speckley is long the FBK forward with $263,000 at risk if the counterparty defaults. 

Question 6

Based on the information in Exhibits 1 and 2, the price of a 6 x 12 Euribor forward rate agreement (FRA) should be closest to:

A. 0.0222.

B. 0.0300.

C. 0.0444.

D. 0.0600.

Correct answer = C

"Forward Markets and Contracts," Don M. Chance
2008 Modular Level II, Vol. 6, pp. 31-37
Study Session 16-62-c
calculate and interpret the price and the value of 1) a forward contract on a fixed-income security, 2) a forward rate agreement (FRA), and 3) a forward contract on a currency
The formula for an FRA price is:



where FRA(0,h,m) is the price of an FRA contracted at time "0" expiring at time "h" for an investment period lasting from "h" to "h+m" and L₀(h) is the h-period Euribor rate at time "0." In Speckley's case, h = m = 180. Using this and the information in Exhibit 2:

FRA(0,180,180) = [ { ( 1 + 0.035 ) / ( 1 + 0.025[1/2]) } - 1 ] x 2 = 0.0444 

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WANT TO KNOW

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