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student07.
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- March 17, 2015 at 12:21 pm #232764
Sir can you please tell me in b part of this question from where is this interest rate 4.25%,4.25% and 4.50% coming.Thanks
March 17, 2015 at 3:25 pm #232786From the strike prices. A strike of 95250 is really 95.25, which is equivalent to 4.75% (100 – 95.25).
A strike of 95500 is 95.50 which is equivalent to 4.5% (100 – 95.50)
Similarly for 95750.The free lectures on interest rate options may help you.
March 17, 2015 at 5:12 pm #232850Thank you sir, i understand that but still the question is not clear.
libor is currently 5% and the company can invest at libor minus 25 basis point
Strike price in question r
95250
95500
95750and in solution three possible collar combination
call strike price put strike price interest rate less.25% less call prem addput prem net
95750 95500 4.25
95750 95250 4.25
95500 95250 4.50i understand everything apart from this interest rate please have a look n explain. Thanks
March 17, 2015 at 5:35 pm #232999The company is investing money and therefore it is buying a call option that fixes the maximum interest rate.
So the first two involve a strike price for the call option of 95.75, equivalent to 4.25%.
The third one has a strike of 95.50, equivalent to 4.50%. These would be the minimum interest rates that they would receive subject to what follows.However, to those minimum equivalent interest rates we need to subtract 0.25% (because options vary with LIBOR and they can invest at 0.25% less than LIBOR) and subtract the premium payable for the call option. However, with a collar, provided they are prepared to accept a maximum interest rate they can sell a put option, and so we need to add the premium they will receive from that.
The final column therefore shows the minimum net interest they will end up effectively receiving.
March 17, 2015 at 6:01 pm #233005Thank u so much sir,its clear now. One thing more i want to ask the strike price were given in different order in question, how would we know which combination of call n put to take.Thanks
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