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January 24, 2019 at 4:34 pm
Hi John, thank you for the great lecture. I still have doubt on Example on why you would subtract £50,000 from the £1,317,523 receipt since the option is not exercise for (a) and why is it worse off for (b) when the spot goes 1.6153?.
Hope you can correct me on my understanding below if anything is wrong. Thank you
Question : Show the outcome on 30 June if the exchange rate..
Exercise Option: $2,000,000 / 1.5200 = (£1,315,789 – £50,000) = £1,265,789 receipt
(a) if spot goes 1.5180: $2,000,000 / 1.5180 = £1,317,523 receipt. This is a Net Loss of £51,734 received Less (£1,317,523 spot – £1,265,789 option)
(b) if spot goes 1.6153: $2,000,000 / 1.6153 = £1,238,160 receipt. This is a Net Gain of £27,629 received More (£1,238,160 spot against £1,265,789 option)
John Moffat says
January 24, 2019 at 7:48 pm
There is no gain or loss with OTC options.
If spot goes to 1.5180 then not exercising would mean converting at spot and getting 1317523, but the premium would still have had to have been paid and so there would be a net receipt of 1317523 – 50,000 = 1267523. If they did exercise the option then the net receipt would have been 1316656 – 50,000 = 1266656. Therefore, they will not exercise the option because converting at spot gives a higher net receipt.
Doing the same exercise if the spot goes to 1.6153, then exercising the option gives the bigger receipt and so they will exercise the option.
Think about it, the higher the spot rate goes then the less the receipt will be if they convert at spot. The whole point of using options is to limit the worst outcome (a higher spot rate will give a worse outcome).
January 25, 2019 at 3:14 pm
Thank you John, now i better understood that option is different on how futures works. basically the spot price of 1.5190 will still be used regardless on whether I exercise the option which i paid for 50,000 pound.
November 29, 2018 at 6:54 pm
Hello sir..now that the pattern of the exam has changed u got to do 3 questions and no choice left..i want to ask what do u suggest is it a good idea to attempt 50 mark question first amd then the othr 2 or do u think it is better to attempt section B first
November 30, 2018 at 8:36 am
I personally would attempt the 50 mark question first, but different people have different preferences. Whichever order in which you attempt the questions, most important of all is to allocate your time properly. It is far better to hand in 3 questions, each of which is only partly finished, than to hand in only 2 questions and leave one question unanswered. You should be aiming to get more than 50% on each of the 3 questions.
October 15, 2018 at 4:15 pm
Hi thanks for another great lecture…
Regarding type of options you mentioned European option twice and explained it both as times that its exerciser able up to end of the option date you may want to look at it again…Thanks again
October 15, 2018 at 5:51 pm
Oops! I am hoping you misheard, but it is probably that I misspoke (it is American style options that can be exercised at any time up to the date).
Thanks for letting me know 🙂
October 24, 2019 at 4:24 pm
So when you state in last c. 60 seconds of video that “in the exam it is effectively it is as though the options are European”, you meant to say American? As in we assume currency options are exercisable at any time up until expiry, unless told otherwise? Thanks John.
October 25, 2019 at 9:02 am
Yes – I should have said American
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