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Good Morning
I was just refreshing the myself on Interest rate options
in Example 6, i see Ange has used the 94.25 strike price to “protect herself from Libor rising above 5.75%”
however, on review, thats not the best rate
94.5 (5.5% + .21%) = 5.71% and is a better choice. isnt this the best choice?
Also..
you mention if the examiner doesnt specifically ask, we should use all the strike prices. However, the Kaplan books use a different Technique.and calculate the net payment by taking the loan int + premium for each strike and then only use the best one, is this a good approach?
There is never a ‘best choice’ because setting different worst outcomes involves using strike prices with different premium costs (and of course the premium is still payable even if the option is not exercised).
In the exam then ideally you should consider all of the strike prices (these days there tend to be only two to choose), although if you are short of time then proving that you know what is happening by just choosing one strike price will get more than half the marks for that part.
I do not have Kaplan books and so I cannot really comment on what they do except insofar (as I have written above) there is not really a ‘best’ strike price.
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