CHAPTER 5: FKLI

ANSWERS FOR SPREADING AND ARBITRAGING

DEC 2016 Q1b - SPREADING
Time Malaysian Futures Market (BMDB) Japanese Futures Market
Today Buy 8 contracts of FKLI @ 1700 Sell 1 contract of Nikkei Index @ 17000
Later Sell 8 contracts of FKLI @ 1780 Buy 1 contract of Nikkei Index @ 18000

Trading profit/loss:

FKLI = (SP – BP) x NOC x RM50

= (1780 - 1700) x 8 x RM50

= +RM32,000

Nikkei Index = (SP – BP) x NOC x Contract value x Exchange rate

= (17000 – 18000) x 1 x YEN1000 x RM4.00
YEN100
= -RM40,000
The value of each index today.
FKLI = 1700 x RM50 = RM85,000
Gross Profit = -RM8000 (Loss)
Nikkei Index = 17000 x YEN1000 x RM4.00 = RM680,000
YEN100
Therefore, 1 contract of Nikkei Index = RM680,000 = 8 contracts of
FKLI
RM85,000

Since Malaysian stock market is expected to outperform the Japanese stock

market, therefore, we should buy FKLI and sell Nikkei Index today.
Dec 2013 Q4a - SPREADING
Time Malaysian Futures Market (BMDB) Hong Kong Futures Market
Today Sell 5 contracts of Sept FKLI @ 1750 Buy 1 contract of Sept HSIF @ 23000

Later Buy 5 contracts of Sept FKLI @ 1760 Sell 1 contract of Sept HSIF @ 24000

Trading profit/loss:

Sept FKLI = (SP – BP) x NOC x RM50

= (1750 - 1760) x 8 x RM50
= -RM2500

Sept HSIF = (SP – BP) x NOC x Contract value x Exchange rate

= (24000 – 23000) x 1 x HKD50 x RM40
HKD100
= +RM20,000

Gross Profit = +RM17,500

The value of each index today.

Sept FKLI = 1750 x RM50 = RM87,500
Sept HSIF = 23000 x HKD50 x RM40.00 = RM460,000
HKD100
Therefore, 1 contract of HSIF = RM460,000 = 5 contracts of Sept
FKLI
RM87,500

Since Hong Kong stock market is expected to outperform the Malaysian stock
market, therefore, we should buy Sept HSIF and sell Sept FKLI today.
 Number of contracts = Amount to portfolio x % of arbitrage x beta of the investment
DEC 2019 Q3b - ARBITRAGING Value of Contract
= (RM10 mil x 100% x 1) = 127 contracts (lots)
(1568 x RM50)
Time BMSB BMDB

Today (Early Invest in KLCI/Buy KLCI Opening Contract

September) worth RM10,000,000 @ Sell 127 Oct FKLI contracts @
1557. Hold temporarily. 1568

Given to us: Later Sell the RM10,000,000 KLCI Offsetting Position

Spot Price = 1557 (End of October = At @ 1588 Buy 127 Oct FKLI contracts @
Oct FKLI = 1568 Expiry) 1588
r = 5.5%
d = 4% FUTURES MARKET
Price later: Both converged at 1588 Profit/Loss = (SP – BP) x NOC x RM50
= (1568 – 1588) x 127 x RM50 = -RM127,000 (Loss)
No. of days to maturity
CASH MARKET
Sept (Started at early Sept) = 1 – 30 Sept 30 days
October (until end of month) = 1 – 31 Oct 31 days
+Increase in Value = (Ending Index – Beginning Index) x Amount of Investment
Total number of days 61 days Beginning Index
= (1588 – 1557) x RM10,000,000 = +RM199,100.83
Step 2 – Calculate the Fair Value of Oct FKLI 1557
FV = SP [1 + r – d] t/n -Interest expenses for borrowing RM10,000,000
FV = 1557 (1 + 0.055 – 0.04) ˆ(61/365) RM10,000,000 X 0.055 X 61/365 = - RM91,917.81
= 1561
+Dividend received of investing RM10,000,000 in KLCI
Step 3 – Compare to Market Price (index) RM10,000,000 X 0.04 X 61/365 = + RM66,849.32
1561 vs 1568
Gross Profit = + RM47,032.34
On the basis of fair value model, Oct FKLI should be traded at 1561 (true price) and
not at 1568 (market price); Oct FKLI is over-priced.
Therefore sell Oct FKLI and buy physical stock RM10 m (KLCI) in the cash market.
 Number of contracts = Amount to portfolio x % of arbitrage x beta of the investment
JUN 2019 Q3b - ARBITRAGING Value of Contract
= (RM2 mil x 100% x 1) = 22 contracts (lots)
(1770 x RM50)
Time BMSB BMDB

Today Invest in KLCI/Buy FBM Opening Contract

KLCI worth RM2,000,000 @ Sell 22 FKLI contracts @ 1770
1760. Hold temporarily.

Later (90 days later) Sell the RM2,000,000 FBM Offsetting Position
KLCI @ 1785 Buy 22 FKLI contracts @
1785

FUTURES MARKET
Profit/Loss = (SP – BP) x NOC x RM50
Given to us:
= (1770 – 1785) x 22 x RM50 = -RM16,500 (Loss)
Spot Price = 1760
CASH MARKET
FKLI = 1770 (maturing in 90 days)
+Increase in Value = (Ending Index – Beginning Index) x Amount of Investment
r = 4%
Beginning Index
d = 2.75%
= (1785 – 1760) x RM2,000,000 = +RM28,409.09
Price later: Both converged at 1785 in 90 days
1760
-Interest expenses for borrowing RM2,000,000
Step 2 – Calculate the Fair Value of Oct FKLI RM2,000,000 X 0.04 X 90/365 = - RM19,726.03
FV = SP [1 + r – d] t/n
FV = 1760 (1 + 0.04 – 0.0275) ˆ(90/365) +Dividend received of investing RM2,000,000 in KLCI
= 1765.40 RM2,000,000 X 0.0275 X 90/365 = + RM13,561.64

Step 3 – Compare to Market Price (index) Gross Profit = + RM5,744.70

1765.40 vs 1770

On the basis of fair value model, the FKLI should be traded at 1765 (true price) and not
at 1770 (market price); FKLI is over-priced. Therefore sell the FKLI and buy physical
stock RM2 m (FBM KLCI) in the cash market.
 JULY 2017 Q3a - ARBITRAGING Number of contracts = Amount to portfolio x % of arbitrage x beta of the investment
Value of Contract
= (RM1 mil x 100% x 1) = 11 contracts (lots)
(1695 x RM50)
Time BMSB BMDB

Today (March) Invest in KLCI/Buy KLCI Opening Contract

worth RM1,000,000 @ 1660. Sell 11 May FKLI contracts @
Hold temporarily. 1695

Later (May) Sell the RM1,000,000 KLCI Offsetting Position

Given to us: @ 1680 Buy 11 May FKLI contracts @
Spot Price = 1660 1680
May FKLI = 1695
r = 7.5%
d = 5% FUTURES MARKET
Price later: Both converged at 1680. Profit/Loss = (SP – BP) x NOC x RM50
= (1695 - 1680) x 11 x RM50 = +RM8,250
No. of days to maturity
March = 1 – 31 March 31 days
April = 1 – 30 April 30 days CASH MARKET
May = 1 – 31 Oct 31 days +Increase in Value = (Ending Index – Beginning Index) x Amount of Investment
Total number of days 92 days Beginning Index
= (1680 – 1660) x RM1,000,000 = +12,048.19
1660
Step 2 – Calculate the Fair Value of Oct FKLI
FV = SP [1 + r – d] t/n
-Interest expenses for borrowing RM1,000,000
FV = 1660 (1 + 0.075 – 0.05) ˆ(92/365) RM1,000,000 X 0.075 X 92/365 = - RM18,904.11
= 1670.36
+Dividend received of investing RM1,000,000 in KLCI
Step 3 – Compare to Market Price (index) RM1,000,000 X 0.05 X 92/365 = + RM12,602.74
1670.36 vs 1695

On the basis of fair value model, the May FKLI should be traded at 1670.36 (true price) and not at Gross Profit = + RM13,996.82
1695 (market price); May FKLI is over-priced.
Therefore sell May FKLI and buy physical stock RM1 m (KLCI) in the cash market.