CFA Level 2 | Economics: Mark-to-Market Value of Forward Contract

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CFA Level 2
Topic: Economics
Reading: Currency Exchange Rates: Understanding Equilibrium Value
It is important to determine whether the currency referred to in the question is the base currency or not. If not, then it is better to make reference to the base currency when determining whether to use the bid or ask rate.
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[@mikefleming4717]

Great video. Thank you!

[@sahilbambroo206]

Very helpful!

[@yasser8129]

Super helpful! Thank you Fabian!

[@FabianMoa]

Glad it was helpful!

[@safeekarzai350]

what a great video, you are legend

[@09abhinavgupta]

Great video, extremely helpful! Just want to know the practical side of this process, how entity deals with Bank for this offsetting forward contracts whether they also charge some extra cost for this offset of Forward Contracts?

[@danad4710]

Thank you for your videos!very helpful

[@FabianMoa]

You're welcome, Dana!

[@sarahli345]

wow, always helpful!

[@mannymanist]

Extremely helpful, thank you sir

[@FabianMoa]

You're welcome, Kevin. I'm glad you found it useful.

[@nishimaarora1858]

great video and extremely helpful explanation! Thanks

[@FabianMoa]

Glad it was helpful!

[@FabianMoa]

How about this? kzbin.info/www/bejne/lWOZl3ppj9utr8k

[@nishimaarora1858]

@@FabianMoa thanks a lot for all your help!

[@ammarrulz]

Good video and explanation!

[@FabianMoa]

Thanks, Ammar!

[@aniketgogate]

in example 1b , arent we in a loss since we r buying at higher rate and selling at lower rate ? plz lmk

[@stevenholden1105]

Hi, Thank you for the great video. One question, how should we detemine when to use bid or ask price for the offset poisition calucation

[@FabianMoa]

If your original position is Long base currency, then your offsetting position is to Sell base currency (so use bid price)

[@baotinnguyen5444]

Hi Moa, how do I take a course CFA level 2 that you're teaching for the Nov 2023 exam?

[@williamgilmore4937]

This is a great video. I see what you are doing. Just out of curiosity though, I have a formula that states to calculate the mark to market value use: (Contract Size)(Forward price to sell base currency - Forward price specified in the contract to buy base currency)/[1 + R(Days/360)]. On Example 2(b) If I plug in (10,000,000)(1.25999 - 1.2873)/[1+(0.0351(3/12))], I get -270,724. Just out of curiosity do you have any insight as to why the formula I have is not working?

[@williamgilmore4937]

Actually, nevermind. I see the issue. I need to take the reciprocal of the currencies and then reverse the order. In other words (10,000,000)(1/1.2873 - 1/1.25999)/[1+(0.0351(3/12))] = -166.909.

[@danleung6851]

Hi, thanks for your video. May I ask why in example 1(a) you are using bid but in example 1(b) you are using offer price?

[@FabianMoa]

Sell base currency (GBP in this example) --> use bid price Buy base currency --> use offer price

[@leejinjoe]

I got a question: when you are quoting USDGBP for 1.2612, means that 1GBP for 1.2612USD. But in forex looks like it means 1USD for 1.2612GBP, based on the base currency definition. How do we understand that? Many thanks!

[@FabianMoa]

In the CFA Program syllabus, the currency pair is quoted as Price/Base; which is different from forex market quotation.

[@leejinjoe]

@@FabianMoa Many thanks!

[@jackbyerley5495]

why is it 12.864-12.625 when you have sold usd for 12.625 (inflow) and bought usd for 12.864 (outflow) - surely that means it is a loss?

[@FabianMoa]

Hi Jack, let's see if this explanation would be clearer: Initially (t = 0), you SOLD GBP 10 million (outflow) forward 6 months and BUY USD 12.864 million (inflow). Six months later (t = 0.5), you want to close your mark-to-market contract, so we have to take an off-setting position, which is to BUY GBP 10 million (inflow) forward 3 months by selling USD 12.625 million (outflow) So, on each currency leg, the net cash flow at MATURITY is: GBP LEG: SELL GBP 10 million (outflow) BUY GBP 10 million (inflow) NET = GBP 0 USD LEG: BUY USD 12.864 million (inflow) SELL USD 12.625 million (outflow) NET USD = 12.864 - 12.625 Hope that clarifies it.

[@johnlin8588]

why do we need to discount the MTM? i get it that there is time value of money, but for MTM (mark to market), we are not interested in the time value of money, but your actual profit/loss in absolute terms. The same applies to bonds and stocks - the MTM of a bond is simply the price you can sell it for today. Can you please clarify?

[@FabianMoa]

That part is explained at 11:12

[@johnlin8588]

@@FabianMoa yes i understand the discounting but if you are MTM, you shouldn't need to care about time value since you are locking in actual losses today. we should not be assuming any investment of the cash at the risk free rate.

[@lukekaram1117]

"The BANK BUYS BASE at BID"

[@kaylabrock5057]

Why wouldn't you do (1+.0124)^(3/12)?

[@FabianMoa]

Hi @Kayla, for Libor-based questions, use Actual/360 (Simple interest) instead of compounding.

[@kaylabrock5057]

@@FabianMoa Great thank you! So I can assume to use simple interest (actual/360) for LIBOR questions and compounding for all other questions (unless specifically stated)

[@FabianMoa]

Yes, Kayla. You are right. LIBOR and EURIBOR should be simple interest, everything else is on compounding basis.

[@shifty9]

Sir quick question, why would you adjust for three months when bring back the amount when its already a 3 month libor? Thanks!

[@FabianMoa]

The 3-month LIBOR is in annualized term (i.e. per annum), therefore you need to adjust for the tenor 3/12