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Sara says

Is Agne premium of 1.4% given in qn?

John Moffat says

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.

kakataj says

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

John Moffat says

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.

kakataj says

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 !

kakataj says

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 !

John Moffat says

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.