# ACCA P4 Interest rate options (2)

1. says

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???

• says

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.

• says

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?

• says

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.

2. says

@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?

• says

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

• says

Oh how nice! Thank you so much.

3. says

Hi Tutor ,

Thanks for the lectures on interest rate risk management .
I was wondering if lectures are available for Swaps ?
Many thanks,

• says

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.

• says

Thanks a lot for your reply. Hope to watch the new lecture soon :).

4. says

Hi how come we are using current future price in calculating the basis as 94.30 and not 94.25?

• says

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.

5. says

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.

• says

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

• says

Dear Sir
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.
God bless

6. says

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.

7. says

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.
Apart from this excellent lecture. God bless.

8. says

Sorry, but there is one more confusion.
How to find strike/exercise price in Interest option?
Will it be 100 – (current libor)
Or
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.

9. says

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.
Thank you.

• says

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.

10. says

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?

11. says

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?

• says

@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).

• says

@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

• says

@htung00, Good point – I will have to think about it. In theory you could buy back the options though.

12. says

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?

13. 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

• says

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!

14. says

this was an eye opener to me on the points i was missing especialy on whether to buy/sell futures & option contracts