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In this question why did the examiner choose the exercise price of 94 and not the others? Are there any criteria before deciding the exercise price?
Moreover, the profit of short selling the futures is 0.92 if the interest rates were 7%. That is not the issue, but my concern is the way it is presented, 0.92 is written as 92 ticks. Isn’t 1 tick = 0.0001? if so 92 ticks must mean 0.0092. Could you explain what 1 tick actually is? It is actually confusing me.
Thank you! 🙂
Relating to the choice of option, will I get marks for choosing either one of the exercise price listed?
Ideally you would show the results for all of the options available.
However, the marks are for proving you understand how options work and so just showing the results for one of the strike prices (but mentioning that others are available) will get you nearly all of the marks.
I tick is the smallest movement. For currency options this is 0.0001. For interest rate options it is 0.01.
I explain this in my fee lectures (although I also explain why I never bother using ticks, and why you don’t need to bother in the exam – it is up to you whether or not you use ticks.)Thank you, John for clearing my query. But there is one more thing that I don’t understand in this qn. If you look at the basis calculation, the examiner has used the settlement price of 93.88 and spot price of 94 to calculate the basis. While spot price is not the issue however, since we are selling the futures now, and want to know the purchase price of futures on the transaction day, why didnt we use the OPEN rate of 93.800 instead of SETTLEMENT rate of 93.88 in calculating the basis? Doing so would’ve given us the right buy price of futures right?
Thank You 🙂
The settlement price is the price ‘now’ at which deals take place – it is not the price at which the deals finish. (The open price is what the price was at the start of the day).
This was confusing, and is the only time in the exam that prices have been given like this. It was the previous examiner – the current examiner does not confuse like this, so do not be worried by it.
Oh! I thought open rate means buy and settlement means sell. Thanks for the clarification, Mr Moffat.
🙂
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