View ACCA AFM lectures Download AFM notes

### Comments

### Leave a Reply

You must be logged in to post a comment.

OpenTuition.com Free resources for ACCA and CIMA students

Free ACCA and CIMA on line courses | Free ACCA , CIMA, FIA Notes, Lectures, Tests and Forums

Mahrukh says

Hi John, I was wondering why options are not given directly on interest rates? Jus

Mahrukh says

Just like forex options.

John Moffat says

Because for trading it is better to have a number rather then a %.

Cathal says

Hi John. Is it true that if we only exercise an interest rate option if the strike price/rate is more attractive than the market price/rate, will the associated future contract always be profitable i.e. a receipt to us (here example 6: Β£34,875 receipt) for interest rate options, and not possibly a loss as in standard interest rate futures (not involving option) or fx futures? And that if I manage to calculate a loss on the interest rate future triggered by exercising an option, that I know I have made a mistake..?

felixb1 says

Hi John,

Have understood and am confident in this area so thanks,

my only trouble is say with options there is possibly 4 solutions to do i.e. interest at 7% with two strikes then interest at 5% with two strikes etc.

So my question is in the exam do we have to work out 4 option premium amounts for example?

my difficulty is almost knowing which solutions to do…

thanks

BR

wasimomarshah says

How do we *not* exercise the option? If the actual interest rate turns out to be lower than our maximum limit, we can’t just keep holding on to the put options we bought. We’d have to close that deal eventually. So how is it possible to not exercise the option when the deal must eventually close?

(hope I phrased that properly)

John Moffat says

No you do not have to close the deal eventually.

The option is the right to buy or sell futures at a fixed price. It is up to you whether or not to use (exercise) that right. If you do, then you immediately buy or sell futures (depending on whether they are call or put options) at the fixed price and at the same time sell or buy futures at whatever the price of them is – just as I show in the lecture. If you don’t want to exercise the right then you do not and the option becomes worthless.

In either case you will of course have paid for the option and as a result you might have ended up wasting money!

It is the same with all options. I assume you had earlier watched the lectures on share options and the lectures on foreign currency options?

abayomi says

The calculation leading to 7.34% as the maximum rate. I thought the premium should have been divided by 4 as in the calculation for premium payable. This would have adjusted the answer closer to the effective rate calculated.

John Moffat says

The premium are quoted as annual rates and so are the other rates. So what is in the lecture is correct π

zhixiang85 says

Thank you John,

On Example 6, I like to ask at what LIBOR rate in 18 September would render the option useless? Would it be anything below 5.75%

Thanks

John Moffat says

No, because the premium would still need to be paid of 0.19%. So it would be anything above 5.75 + 0.19 = 5.94%

ab619 says

Thank You for the lectures Sir.

When asked to choose a strike price ,why cant we choose(in this sum a put option) based on the strike price giving us the minimum net cost?

Example

5.75% (94.25) + .19% = 5.94%

5.5% (94.5) + .21% = 5.71% (Choose this one because of overall min cost)

5.25% (94.75) + .48% = 5.73%

John Moffat says

Although there would be no point in choosing 94.75, the problem between the other two is that although 94.5 end up giving a lower minimum, if the interest rates move in our favour then we would not exercise the option but would still have to pay the premium which is higher than it would have been had we closed 94.25.

For this reason, it is not a question in the exam of stating what the ‘best’ strike price is, but the marks are for proving that you know how we use options and how they work π

ab619 says

I had mentioned the min. net cost because i had noticed in one of the kaplan texts that this is the way for determining the optimum strike price.

So this method i showed you earlier, is it valid to practice that or do i have to do the calculations for 2 strike prices and then comment which one to purchase?

John Moffat says

Ideally in the exam you should show the results for all of the exercise prices available. However if you are short of time then you will still get most of the marks for showing the workings for one strike price and stating that others are available – most of the marks are for proving that you know how options work π

ab619 says

Thanks Sir.

John Moffat says

You are welcome π

aaishas says

Hello Sir,

What do we do when there are 2 libor rates given in question?

Do we do the entire calculation twice for options?

John Moffat says

There is only ever one LIBOR rate at any one time π

(If you are asking about questions which tell you LIBOR might go up or down on the future date, then yes – if it wants calculations then you do them twice.)

aaishas says

Yes I meant if it says LIBOR could go up and down. Because this June attempt the same happened. DOing the entire calculation twice is time consuming. :O Its a challenge!.

But thanks π

John Moffat says

When you have done it once, it does not take so long to do it a second time because much of the workings are the same.

aaishas says

kk thanku so much Mr John π

John Moffat says

You are welcome π

John Moffat says

Yes. The important thing though to get the marks is really to prove that you understand how options work. For this you could choose any strike price provided you then discussed the outcome and the fact that there were others available.

jesley says

Woah…really? That would be okay too?

John Moffat says

You might lose 1 or 2 marks, but you would certainly get most of them.

mjibola says

Since we are choosing a strike price of 94.25 because its respective interest rate is the closest to 5.75%, what if the 94.25 strike price isn’t among the options table, do we choose the next best strike price, 94.50 = 5.5%?