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Hi sir,
1.I have watched your lectures on Interest rate options and collar sir here l was wondering how l will calculate the gain or loss on the futures if l will exercise the option,so l don’t know at what price l am buying and at what price l am selling the futures cause as a depositor l am concerned about interest rates falling and when the interest rates fall the value of the futures increase so l would buy the futures now and sell then later but l don’t know at what price l am buying and what price l am selling2.Sir the other thing l don’t understand is why we have different strike prices for the futures and the options it is confusing me in deciding which price to buy the future and which price to sell
I loved your lectures,they simplify a lot,
Thank you
3.Sir l also don’t get the logic behind the expected futures price calculated in the solution
4.Sir under the collar solution in the second scenario if the interest rates fall,and both the options are not exercised there is still an amount of interest received which is the same like in the case of the options1, 2 and 3
The futures prices given in the question are for futures maturing at either end of September, end of December, or end of March. Because the deposit will be in November they will deal in December futures.
We know the futures price now, and to calculate what the futures price will be in November (if interest rates fall by 0.5% we apportion the basis in the way that I explain in my lectures.
4. I do not understand what you are asking. The collar is created by using options – but limits both the maximum and minimum interest that will end up being received.
1.Ok sir so suppose when looking at the options
Interest rates fall by 0.5 %=3.6-0.5=3.1%
Sept
Int rate=100-3.6=96.4
Futures price=95.94
Basis=0.46Nov
Int rate=100-3.1=96.9(assuming in this month interest rates fall by 0.5%)So till december the basis reduces in a linear manner to zero
So the unexpired basis between Nov to Dec is as follows:
From end of Sept to Dec there are 90 days
So the unexpired basis =30/90*0.46=0.1533Therefore,The november futures will be 96.9-0.153=96.747
Since it is a depositor he will buy call options now and sell them later when interest rates are low
So the options will be bought at 95.94 and sold at 96.747No of contracts=25,000,000*6/3/1000000=50 contracts
Interest received=(3.1-0.4)*50,000,000*6/12=675,000
Gain on the options=50*1,000,000*[(96.74-95.94)/400]=100,000
Premium=(0.182/0.01)*25*50=22,750(strike price of 96.5)
Net receipt=675,000+100,000-22,750=752,250
Effective interest rate=752,250/50,000,000*12/6=3.0%
Sir l kindly request to please correct me
Thank you
4.Sir how come the way they are solving the collar in the suggested solution,is not the same as in the lecture,Sir l humbly request you to explain to me the suggested ACCA solution on the collar if interest rates fall by 0.5% to 3.1%,Sir l don’t understand that neither of the call and put options are exercised but there is still an amount of interest received shown
But you can see from the examiners answer where you have gone wrong.
You started off wrongly. We are using December futures and the price of December futures as at 1 September is 95.76 and not 95.94 as you have used (that is the price of September futures, and we are not using September futures because they mature at the end of September and the deposit is not being made until the end of November).
With regard to the collar, the examiners answer is dealing with the options in exactly the same way as I deal with interest rate options in my lectures. The only difference is that he has used ticks to calculate the gain and the premium, but I explain ticks in my lectures (although as I also explain, you never need to use ticks and the gain and the premium come to exactly the same result).
I do suggest that you watch the lectures on interest rate futures and options again.
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