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Hi, I have 2 doubts in this question:
1)
I got the basis risk to be 0.18 as the examiner. But out of curiosity, I tried to calculate the lock-in rate and then the net payment. But I didn’t get the same answerLock in rate = 100-(96.16+0.18)=3.660%
As Alecto Co can borrow at ESTER + 80, lock in rate = 4.460%
Therefore the net payment should be = 37*1,000,000*4.460%*5/12=6,87,583Please tell me in which step I have made a mistake.
2)
In the question about options on IRF, two exercise prices have been given.
Do we calculate the net cost and effective interest rates for both strikes or for only the strike with the lowest cost as we have bought a put option on the IRF?1. The amount being borrowed is $22,000,000.
Therefore using the lock-in rate gives 4.46% x $22,000,000 x 5/12 = $408,833
2. When two exercise prices are given then ideally you should show the calculations for both. (You cannot say in advance that one is better than the other because although the premiums will be different, so will the ‘worst outcome’ be different.)
However if you do not have time then just showing the calculation for one exercise price will get more than the half marks needed because you will have proved that you know how options work, which is what the examiner is more concerned with.
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