Mock Exam D- Q16

[vkichoi]

How do we know that if we hedge we get $50,000 future CF?
Is is the expected future CF? 50% *($0 + $100,000)
Thanks!

 

[David Harper CFA FRM]

Hi vkichoi See here http://forum.bionicturtle.com/threads/l1-t1-41-tax-argument-for-risk-management.3552/#post-9532
The firm can "lock-in" any net cash flow (where net is a combination of the uncertain cash flow and the gain/loss on the hedge); e.g., if the firm could short at $80, then $80 is locked-in because:

• If underlying flow is zero, then short gains 80; or under the binomial:
• if underlying flow is 100, then short loses 20, such that 100-20

However, the lack of any systematic risk ensures that F(0) = E[S(t)] such that the forward price available should be, as you suggest, "the expected future CF? 50% *($0 + $100,000)"

Candidly, I don't love this question, it's too much Stulz, I am tagging it for replacement in our next (2014) version, thanks,