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September 5, 2017 at 10:03 pm
If we were asked to calculate the hedging efficiency for this type of hedge would it be:
34,875-7,125/400,400 x 100% = 69.3%
or would we ignore the cost the premium:
34,875/400,400 x 100% = 87.1%
John Moffat says
September 6, 2017 at 9:21 am
You wouldn’t be asked for the hedging efficiency 🙂
August 23, 2017 at 5:29 pm
How do we know which option to use when we are given different rates. The model answers calculate all the outcome of all the rates. Is that how we should do them?
August 24, 2017 at 6:17 am
There is no ‘best’ strike price and so ideally you should show the calculations for all of them.
July 24, 2017 at 5:39 am
Another great lecture sir. I would like to ask if interest rates fall below the interest rate of the option ie below 5.75, what then would happen? Would the option be sold at the end of September?
July 24, 2017 at 8:26 am
If the interest rate fell then you would just ‘throw away’ the option. Nobody would buy it from you because it would not be worth anything.
Buying an option is a bit like paying for insurance. If the interest rate goes up then you are protected (you would exercise the option) but if the interest rate goes down then you don’t use the option but pay less interest. To get the benefit of the protection you have to pay the premium at the beginning.
July 24, 2017 at 4:00 pm
Understood sir 🙂
July 24, 2017 at 8:54 pm
You are welcome 🙂
May 21, 2017 at 9:11 am
Please under interest rate collar what is the bases for selecting the strike price to the used for the put and call option
May 21, 2017 at 10:03 am
It depends whether you are borrowing or depositing, and what strike prices are available. There is no ‘best’ combination for a collar – the more you restrict the difference, the lower the net premium will be.
Do read my article on collars:
Kit Sophal says
May 21, 2017 at 7:37 am
thanks for your clear lecture. I am not sure why we sell at strike price because this is put option. Do i miss something?
May 21, 2017 at 10:01 am
A put option is the right to sell a future at a fixed price (the strike price). So exercising it means buying the future at whatever the price happens to be, and immediately selling it at the strike price.
March 5, 2017 at 7:00 am
Hi there – thank you so much for these lecture. It’s really top quality. I’m just struggling with one aspect when calculating the premium on Interest Rate Options. I understand all components except for the dividing by 400. I would understand if it was just divided by 100 – and I appreciate the fact that you say it’s ALWAYS divided by 400 but why? I assume it’s related to the fact that we’re dealing with 3-month interest rate futures – is it because the premium is quoted as an annual price and needs to be divided by 4?
March 5, 2017 at 9:07 am
I do explain this in my lectures. You divide my 100 because it is a %, and you divide by 4 because they are three months futures.
October 22, 2016 at 10:15 am
hi Sir, can u please upload the answer for example 7?
October 22, 2016 at 2:48 pm
I will at some stage, but for the moment there is a detailed note on collars that is linked from the main P4 page.
October 23, 2016 at 6:23 am
noted. will wait for your answer as wanna know the step by step answer
October 23, 2016 at 8:19 am
August 29, 2016 at 6:20 pm
why is der any lecture on business valuation .?
August 29, 2016 at 7:43 pm
Maybe sometime I will record one, but there are no techniques involved that are not covered in the earlier lectures.
In addition I have recorded several lecture working through past exams questions on this (you can find them linked from the main P4 page as ‘P4 revision and past questions’.)
July 5, 2016 at 8:02 am
Thank you for your lectures, they help me a lot! Watched all of them for p4
I have the question about effective interest rate on interest rate options in the example 6.
when we calculate it we add premium to the paid amount of interest and to the gain from the option. However we paid premium in advance on ?ug 13, and other amounts on Sept 18.
Shouldn’t we consider time value of money for the premium, and use its NPV on Sept 18, to calculate effective interest rate? e.g. 7125*(1+r)? Thank you!
July 5, 2016 at 9:18 am
Yes you can, and occasionally the examiners does this in some of his answers.
However it is a minor point – the marks are mainly for proving that you understand how options work.
July 5, 2016 at 11:59 am
July 5, 2016 at 7:20 pm
June 18, 2016 at 9:32 am
Hello !!! I want to say that there should be 31days in august not 30 days.
June 18, 2016 at 4:10 pm
So there are! 🙂
July 5, 2016 at 8:12 am
Haha- I also calculated 17 days in August in this example)))
May 26, 2016 at 8:45 pm
September future price in August was 94.3 or 94.25? what did i miss here? did you just round off?
May 27, 2016 at 7:35 am
You can see from the question that the futures price was 94.30.
It is the option that has a strike price of 94.25.
June 15, 2016 at 6:16 pm
Dear sir why we use strike price 94.25 we can sale 13 august future price which is 94.30 by doing this we pay less interset ?
May 26, 2016 at 10:23 am
Thank you a lot for your lecture
I have one question, though.
How was it possible to exercise the put option on Sep 18th?
They are quoted to mature at the end of Sep, i.e on Sep 30th.
Or are they American type of options?
May 26, 2016 at 11:50 am
In the exam you effectively do assume that they are American style.
(In practice, even though you cannot exercise European style options early, what you can do is sell the option which will have the same effect.)
May 15, 2016 at 3:39 pm
example 7 chapter 20 has no answers at the back. Could you please advise?
May 15, 2016 at 3:51 pm
No there isn’t and I must add an answer.
However, I have written a full explanation of how collars work – you can find it linked from the main P4 page.
May 15, 2016 at 1:02 pm
In previous examples, when predicting the effective interest rate we added the changes in basis risk. Why do we use the premium this time?
Why did you use the 94.25 as your strike price? If we were ask to determine the most suitable strike price how would you do this? Would you assume to take the strike price closest to the LIBOR rate on the 13/08 (ie 5%) hence the strike price closest to 95.00. Or would you take 6,4% hence the strike price closest to 93,6?
May 15, 2016 at 2:07 pm
Firstly, we can’t predict an effective interest rate because these are options. All we can do is determine the worst interest rate we could suffer (because if interest rates moved the other way then we would not exercise the options).
Secondly, since the premium is payable whether or not the option is exercised it makes the overall cost greater (there is no premium payable when we are simply dealing in futures rather than using options).
Thirdly, there isn’t really any such thing as a ‘best’ exercise price. This is because although different exercise prices create different ‘worst’ outcomes, for better ‘worst’ outcomes you pay a higher premium which might end up being wasted if we do not need to exercise the option. In the exam, ideally you would calculate for all available exercise prices and then discuss (which actually does not take too long – once you have done it for one it is rather repetitive). However if you are short of time, just illustrating for one exercise price (and then discussing) would get most of the marks – the marks are mainly for proving that you know how options work.
May 15, 2016 at 3:31 pm
thank you very much
May 15, 2016 at 3:49 pm
March 23, 2016 at 10:59 am
Is Agne premium of 1.4% given in qn?
March 23, 2016 at 2:05 pm
I assume that you have downloaded the free lecture notes (otherwise there is no point in watching the lectures!).
In the question is says that LIBOR is currently 5% and that Agne can borrow at 6.4%. Therefore she is paying a premium of 1.4% above LIBOR and we always assume that the premium will remain constant.
October 31, 2015 at 12:25 pm
HELLO SIR JOHN
IN THIS QUESTION THERE ARE 3 STRIKE PRICES ARE GIVEN FOR PUT OPTIONS ,PRIMIUMS (NET RECIPTS)
94.25 0.19 94.06
94.50 0.21 94.29
94.75 0.48 94.27
STRIKE PRICE OF 94.50 GIVES HIGHEST NET RECIPT OF 94.29 ,WHY YOU STILL USE STRIKE PRICE OF 94.25
KINDLY EXPLAIN …I AM STUCK
October 31, 2015 at 1:24 pm
Please do not type in capital letters.
The problem is that although one strike price will give the best ‘limit’ it is also has the highest cost/premium (and the option might not be used depending on what he eventual interest rate actually is).
We don’t know what the eventual outcome actually will be, and therefore we need to look at all the choices of strikes and then discuss.
November 1, 2015 at 7:29 am
sorry about that..
so please correct me if i am wrong
if there are 3 strike prices given in the exam,we must have to demonstrate maximum cap of each strike price given ! and there relevent premiums, then we chose which ever seems best and compute our answers !
November 1, 2015 at 7:30 am
November 1, 2015 at 10:25 am
Although most of the marks are for proving that you understand how options work, ideally (subject to how much time you have available) you should look at all the strike prices and then discuss.
As I wrote before, it is rare that you can say that any one of them is definitely the best (if interest rates fall and we don’t exercise the option then the one with the lowest premium would be best, but if interest rates go up then the one with the lowest maximum would be best, but obviously we do not usually know what is going to happen in the future) – it is more a question of discussing in the exam, and again proving that you understand how they work.
October 31, 2015 at 12:02 pm
do the futures price on 13 august have no use here in then??
October 31, 2015 at 1:26 pm
The current futures price has do direct relevant (because we will only deal in the futures if we exercise the option and the trade will take place on the date we exercise the option).
However, in exams we will usually need to know the current futures price (and the current basis) in order to be able to calculate what the futures price will be on the date the option is exercisable.
August 29, 2015 at 11:58 am
In the last part of the video where we calculate the prediction of maximum rate, you say that we cannot say which is the better of the two option between strike 94.25 and 94.50.
But since we calculated that the total maximum cap. for 94.50 is 7.11% which is lower than the maximum cap. of 94.25 which is 7.34%, wouldn’t we be allowed to say that strike price of 94.50 is better since our payable of maximum interest rate is cap at a lower rate of 7.11%?
August 29, 2015 at 4:23 pm
It certainly will end up better if interest rates go up.
However, the problem is that it costs more and so if interest rates fall then we will have ‘wasted’ more money.
Options are attractive if you think interest rates will fall, but you want protection (‘insurance’) in case you are wrong and they increase.
May 21, 2015 at 7:50 am
Noted in a technical article on interest rate risk management a question on Titans FC that the LIBOR 6% translating to 94 and the futures price is also the same 94 on today’s date ie 15th Dec….. how can we calculate the futures price on its maturity?
May 21, 2015 at 10:19 am
In the article, the futures price is not 94 !!
The price on 15 December of March futures is 93.790.
So the basis is 94 – 93.790 and we assume that this falls to zero over the life of the future.
April 14, 2015 at 5:00 pm
IS THIS IT? NO MORE LECTURES IM SAD
April 14, 2015 at 5:07 pm
What more lectures are you wanting? 🙂
(and there is one more after this one on interest rate swaps)
April 15, 2015 at 8:34 am
when? I so enjoyed all the lectures if I don’t pass this exam it will be all my fault. Excellent lectures!
April 15, 2015 at 8:59 am
Thank you 🙂
April 15, 2015 at 9:56 am
When? Thank You for your excellent lectures!
March 11, 2015 at 9:07 am
Wow John you are a truly gifted, you make P4 seem so easy to understand and having used F9 and passed this registered so quickly…..many thanks.
Will you be posting lectures on SWAPS?
Thank you again!
April 14, 2015 at 5:06 pm
There is now a lecture on swaps 🙂
December 14, 2014 at 9:58 am
where can i find lecture videos for swaps
December 14, 2014 at 11:28 am
Sorry but there is not yet a lecture on swaps.
November 27, 2014 at 1:08 pm
Great lecture but I am still not clear on the basis for choosing a strike price. In exam conditions, should we just go with the strike price that has the lowest premium as a rule?
November 27, 2014 at 2:44 pm
Ideally you should illustrate for all the strike prices. If you do not have time then illustration with just one will get the majority of the marks. The main thing is to prove you know how options work.
November 11, 2014 at 8:16 am
In example 6 the option is exercised on 18th September. But I thought that European options can only be exercised at the end of the month they are referred to by. So how does this work in practice? Many thanks, these lectures are so helpful.
November 11, 2014 at 10:01 am
It is true that european options can only be exercised at the end of the month.
However, since they are traded options, then way it works in practice is that you sell the option 🙂
November 1, 2014 at 5:37 pm
u didnt use ref point in this example… 🙂
December 4, 2013 at 12:00 am
Question 2 of December 2013 was unbelievable! All thanks to you John Moffat, you are the best!
November 27, 2013 at 10:53 am
In this example, we were told that Agne wanted to use the strike price of 94.25. What if in exam, the question asks as to choose an option that would be most effective?? Do we solve the question by using all 3 strike prices or can we advise by calculating the maximum effective interest rate???
November 27, 2013 at 8:00 pm
Choose a strike price that is close to the current LIBOR. The BPP text book says and I quote: ‘Make sure you read the question carefully to determine whether you have been told which strike price to use. If you have not been told you can choose the strike price closest to the interest rate – for example if the interest rate is 3% then you would choose an exercise price of 97.00.’ I hope this helps.
November 27, 2013 at 8:13 pm
Ok. thanks. So just to be sure… SUPPOSE in Agnes example. we werent told which strike price to use, then as the current LIBOR given in the example is 5%, then we would have used strike price of 94.75, as that is closest to the current LIBOR??? Correct?
November 27, 2013 at 9:14 pm
And what about Currency options?? Do we use the same point of using the exercise price nearest to spot rate or is there some other way?? In BPP book, it adds/subtracts premium from call/put option to arrive at a net and then decides which one to chose based on the most favorable.?? Thank u.
November 15, 2013 at 5:40 am
@Johnmoffat am so thankful for providing us with these free lectures. They are sooo helpful especially here in New Zealand where we don’t have lecturers for optional papers, so these lectures are my only hope.
I have a question concerning Q.5 of December 2008, we have been given the futures open and settlement prices. Which of these two do we use when calculating basis? I know we use the current LIBOR, but which futures price do I use, open or settlement? And why?
November 15, 2013 at 12:45 pm
You should use the settlement prices.
(Open is the price at the start of the day, settlement is the average price for the day)
I would not worry too much about this. The question you are referring to was set by the old examiner who was replaced 🙂
November 16, 2013 at 9:29 pm
Oh how nice! Thank you so much.
October 17, 2013 at 2:57 pm
Hi Tutor ,
Thanks for the lectures on interest rate risk management .
I was wondering if lectures are available for Swaps ?
October 17, 2013 at 3:57 pm
At the moment, I am afraid that there is not a lecture.
I will record one in the future, but it will have to wait until I have a break from teaching.
October 18, 2013 at 2:16 pm
Thanks a lot for your reply. Hope to watch the new lecture soon :).
October 2, 2013 at 4:08 pm
Hi how come we are using current future price in calculating the basis as 94.30 and not 94.25?
October 2, 2013 at 4:53 pm
The current basis (on 13 August) is the difference between the current spot rate, and the current price of the September future (which is 94.30).
As the spot rate changes, so to the price of the futures – we can estimate by assuming that the basis (the difference) falls linearly.
94.25 is an exercise price (not a futures price). All it means is that if we choose to exercise the option then we have the right to buy or sell (depending whether put or call) a future at that fixed price. We would only exercise if we would make a profit, and the profit will be the difference between whatever the futures price is on that date, and the exercise price.
August 22, 2013 at 3:55 pm
It is said in the course of lecture while counting broken period days for option that August has got 30 days. Does it mean that we have to count 30 days uni formally by taking into account 360 days in a year.. Or we have to count actual number of days in that case From August 13 to August 31 , they are coming 18 days. Kindly clarify.
August 22, 2013 at 6:14 pm
Ooops – there are 31 days in August. I made a mistake – sorry.
However 1 day will not make any real difference so I am not too worried 🙂
August 22, 2013 at 6:30 pm
My purpose was to get clarity about counting number of days. It is very good lecture.
You are doing very nobal job in making available such a quality stuff at free of cost across globe.
August 20, 2013 at 12:22 pm
Very nice lecture.
My only doubt is that it was told in the course of lecture that August has got 30 days so while counting days from August 13 it was taken as 17 days for August + 30 days for September.
On this background
1) Since August has 31 days actually but for the sake of calculation should we be presuming that Year has got 360 days and every month ( including February) has got 30 days invariably
2) If not by taking into account actual number of days in August it becomes 18 days in August + 30 days in September.
Can you kindly throw light on this.
August 20, 2013 at 9:06 am
Very nice lecture. Only one doubt -it was said during the course of lecture that while counting days for August that August has 30 days so remaining days in August being 17 + 30 for September. My doubt is
1) Should we be assuming 360 days in a year and uniform 30 days in every month while counting the days for Interest Rate Options. or
2) We have to take actual number of days in that case it would have been 18 days in August from August 13 , leaving 13 and counting remaining 18 days.
Please throw light on it.
Apart from this excellent lecture. God bless.
May 20, 2013 at 10:33 am
It went over my head 🙁
April 24, 2013 at 8:52 pm
Sorry, but there is one more confusion.
How to find strike/exercise price in Interest option?
Will it be 100 – (current libor)
It will be 100 – (maximum borrowing rate borrower is ready to pay)
In examples we took exercise price as 94.25 (100-5.75)
But in December 2008 question of PHOBUS CO. exercise price is not 100-6.6.
April 23, 2013 at 12:03 am
I’m a bit confused. In last lecture we estimated future price by subtracting future interest rate from 100, that was 85(100-15).
Why don’t we do the same in this question? Why can’t we calculate future price by subtracting LIBOR of 6.5% from 100 to find the future price.
I mix both the methods. Kindly tell me when to use which one.
April 23, 2013 at 7:03 am
The previous question was a ‘baby’ example to explain the principle.
In practice the futures price will not be ‘perfect’ – i.e. it will not be exactly 100 – the interest rate. The difference between the actual futures price and the ‘perfect’ price is the basis risk – we assume that this difference falls to zero by the end of the future.
April 23, 2013 at 7:18 pm
Thank you 🙂
November 18, 2012 at 8:28 am
Hi thanks for such a clear lectures! but i have one question
As the cost of selling additional contract is less than benefit from this contract on 18 September, why should we limit the number of contract to 30?
Is it becouse we take this desicion on 13th of August?
November 18, 2012 at 9:06 am
@azinbu, Yes – it is because the decision has to be made ‘now’.
November 13, 2012 at 11:08 am
arent there lectures on forex swaps and interest rate swaps?
October 1, 2012 at 4:17 am
For example 7 of this chapter it asks to how Agne could use a collar to hedge.
How is the hedge effectivness calculated if we’ve sold september call options that are exerciseable upto September 30 and our own transactions end on September 18.
Is the hedge efficieny and effective interest rate only calcuable until after September 30 when the options expire?
October 1, 2012 at 3:28 pm
@htung00, If the options are American style, then they can be exercised at any time up to the end of the relevant month. If they are European style then they can only be exercised at the end of the month (but they could be sold earlier at whatever the price happened to be on the date of sale).
October 1, 2012 at 3:41 pm
@johnmoffat, in example 7 we bought put options and sold call options to create a collar. With the put options we can sell them anytime, but my problem is with the call options we sold.
They once sold we have no control of when it is exercised we where able to calculte the profit from selling the put options on 18 sept but we still wouldn’t know the complete effect of the call options as there is still oppurtunity for loss until sept 30
October 1, 2012 at 4:05 pm
@htung00, Good point – I will have to think about it. In theory you could buy back the options though.
April 27, 2012 at 5:31 am
Very helpful. Thanks a lot.
February 25, 2012 at 8:33 am
November 26, 2011 at 11:44 am
November 23, 2011 at 11:11 am
lectures on int rate risk mgmt were very helpful to me cuz i had no access to physical tutor in town. Thanks OT.
I’ve a particular question on this Int rate option (2) lecture. In the end, lecturer says its hard to decide amongs strike prices 94.25 and 94.50. I understood the calculations but what’s the logic in avoiding selecting the best strike price. Can anyone tell me?
June 17, 2011 at 9:49 am
It stops at the minute 7.27
May 17, 2011 at 5:46 pm
i actually now get the reasoning behind futures and options. i am pretty sure it would be one of my questions to answer should it show up in the exams
I am predicting international investment appraisal to be there as it’s been quite sometime now since it’s been examined. Any tips
November 22, 2011 at 12:34 am
did you succeed in June or you have to retake it?
Now in December it will be my second attempt…
the June exam was really tough, or i was not prepared enough…
Good Luck to you!
May 16, 2011 at 3:36 pm
this was an eye opener to me on the points i was missing especialy on whether to buy/sell futures & option contracts
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