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Investment / Financial Markets Old Exam MFE Forum

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  #1  
Old 02-23-2019, 01:32 PM
Frustrated & Unmotivated Frustrated & Unmotivated is offline
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Default these damn signs are confusing me...

I'm just doing questions again re arbitrage etc.

+ means positive cashflow, right? and - means negative, so selling somehting means you get the cash so it's a + (right?) and borrowing means you also get the cash, so also a +, (right?)

but then in the replicating portfolio models, - means borrowing? and + means buying?

I keep messing up these questions and can't get this straight. I can do the math, but the verbally interpretting is where I get confused.

Sorry for such a stupid question...
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Old 02-23-2019, 01:58 PM
RoyalMath15 RoyalMath15 is offline
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I get confused on these sometimes too, but the way that I have been remembering it is as follows:

In general, we replicate the option by buying delta shares of underlying stock, and lending the amount B at the risk free rate.

So, if we have a negative B, we are lending a negative amount, which is borrowing. If we have a positive B, by the definition above we are lending money. Similarly, if we have a negative delta, then we are buying a negative amount which is selling. If we have a positive delta then by the definition above we are buying.

I am not sure if you have the Coaching Actuaries manual, but they do a pretty decent job of explaining this in their videos on the topic.

Your statements about cashflows above were all correct, to the best of my knowledge. I kind of just think as replicating portfolios as a different rule of thumb than the cashflow profit problems.

I hope this helps!
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Old 02-24-2019, 03:04 PM
lowkey__ lowkey__ is offline
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The way that worked out for me:

We consider two perspectives - Value/Price Perspective and Cashflow Perspective.
In Value/Price Perspective - longing assets (+); Shorting assets (-)
In Cashflow Perspective - longing assets (-) ; Shorting assets (+)

Once I read the question, I am generally able to figure out which of the above two perspectives, I want to use!
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Old 03-03-2019, 09:14 PM
eruben1007 eruben1007 is offline
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I struggle with this too --- how do we know which one to use when calculating elasticity?
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Old 03-04-2019, 12:27 AM
lowkey__ lowkey__ is offline
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Elasticity would be cashflow perspective. I just solved a question on this today. It was something about the elasticity of the portfolio.

Since I knew I was dealing with a portfolio and elasticity formula takes into consideration weights, it made more sense to me to use cash flow perspective.

Not sure if this would be helpful... worked for me though!
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