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dear sir I have a silly doubt in this question and that is the closing future price of 95.74 is if interest rates decrease by 0.5% and 96.74 when interest rate increases so why while calculating options theyve mentioned 95.74 under ‘ if interest rates increase by 0.5%’ and 96.74 under ‘ if interest rates fall by 0.5%??
also sir how many decimal places is basis points if the basis points is 0.21 how many decimal places do we write it to?
thanks
If interest rates increase then the futures price will fall, and if interest rates fall then the futures price will increase. I think you are misreading the answer, because this is the case in the answer.
1 basis point is 0.01 (1%) and you should write it to 2 decimal places.
Hi John,
I’ve noticed that model answers to options always calculate the results for all possible strike prices for given options (e.g. both December strikes in this question).
I’ve been told to chose the most favourable strike price and calculate the result for that one only.
Would I lose any marks for doing this (assuming I will give an explanation why I’ve chosen that strike price, e.g. to maximise receipt) or would that be ok?
I don’t want to lose any easy marks, please let me know.Thanks,
GosiaThere is no such thing as a best strike price. Setting tighter limits is great if the exchange rate (or interest rates) move against us, but the option will cost more and the premium will be wasted if things move in our favour.
Ideally you should show calculations for all available strike prices, and then briefly discuss. However the marks are really for proving how options work, so if you are short of time then just illustrating with just one strike price will still get most of the marks.
Hi John,
thank you so much for the reply.
On the revision course we were told to:
1. for put options – deduct premium from strike and pick the one which gives lowest interest for borrowings
2. for calls – add premium to strike and choose one which gives highest interest on depreciation.The other thing was, we’ve been told that as some students struggle with basis, just to omit this and use futures price for the calculation.
Having done both of the above, I received very few marks on my mock exam for the hedging question.
I assume that if I don’t really have any problem with either doing calculations for all strike prices, or calculating the basis, I should just do both to be able to get as many marks as possible.
thanks,
GosiaI don’t know why on earth you were told this on your course.
You should aim to show the calculations for all of the available strike prices, as I wrote before.
As far as the basis is concerned when dealing in futures, it is the most important point in relation to futures and it is something that needs to be learned.
Have you watched my free lectures on the management of interest rate risk? If not, then you may well find them helpful.
Thank you so much for the reply.
I have been told that:
– for put options deduct premium for strike and pick one that gives lowest borrowing rate
– for calls add premium to strike and pick one that gives highest rate for depositI’ve got no problems with calculating them so I’d rather do calculation for all given strike prices to make sure I can get all the marks 🙂
On the revision course I’ve also been told to leave off the basis calculation as students find it complicated and it’s only worth 1-1.5 marks and just use the futures price given.
But when I got my mock paper marked I lost quite a lot of marks on the hedging question by following both of the above.I assume that, as I’ve got no problems with the calculations, it’d be better to actually do them for: 1. all strikes and 2. calculate the basis?
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