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Interest rate risk management (1) Part 5 – ACCA (AFM) lectures

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  3. Please explain, am very confused? I don’t understand in which case we have to…
    • Sell put option
    • Buy put option
    • Sell call option
    • Buy call option

    I don’t get it why we doing this when its come to interest rate & exchange rate????? Is there any method to understand this?

    • We use options in order to limit the ‘worst’ outcome as either the interest rate or the exchange rate changes.

      Have you watched all of the lectures on the management of exchange rate risk and the management of interest rate risk (and read the lecture notes that go with the lectures), because I do explain the reasons and the rules in full.

  4. Dear John,

    Please I would appreciate if can explain me with regards to Chp: 20 example 07, why you said “buy put option” and “sell call option”? As I know “put option for sell” and “call option for buy”.

  5. Hi sir at 22:55 minutes of the lecture sir why to the 6:65% we are adding the 0.18% aren’t we receving the 0.03% so shouldn’t we deduct the 0.03% here to the 6.9% we are adding 0.18% to look at the net interest saving by having a floor but l didn’t get the logic as to why we are adding 0.18% to 6.65%

    Thank you

  8. Dear Sir. One question is that you said that the better collar would be where the min is lower at 7.1% which was a counting mistake. 6.65+ 0.16 = 6.81
    So from both of these collars can you please tell which one would be better now ?
    6.81% – 7.31%
    6.83% – 7.08%
    I’ll be waiting
    Thanks

    • You cannot say which is better (and the exam will not ask you to). You will be either asked to illustrate how a collar could be used (as this example does), or asked to advise in which case you would state the various limits, the net cost, and discuss.

  9. HI John,

    Create work, just regarding interest rate options and futures.

    Can you do all the work in percent and not calculate the actual profit on futures or options in amount

    ie have an answer like this regarding options (borrowing)

    gain on option 1%
    libor is 6%
    premium cost 0.3%

    total cost is 5.3%

    will you get full marks? its just so much quicker

    thanks

    Felix

    • It is quicker and you would always get some of the marks. Whether you would get all the marks depends on precisely what the question asks for.

      The problems are (as I do show in the lectures) that because of basis risk the gain will not be exactly 1%, and that because of contract sizes it will only apply to the contract amount.

  10. Dear John,

    When selling Call Option to the depositor would it refer to as “Shorting/ Short Sell”? because the impression was Agnes selling something which is not owned.

    Likewise it is possible to sell a Put Option to a borrower? Thank you.

    • In practice, what you say is true – selling anything that you do not own is short-selling.
      However the way the exam questions are phrased, it is better to assume that we are the provider of the option (as opposed to selling an existing option) and that therefore it is our responsibility to fulfil the option should the buyer of it choose to exercise it.

  12. Hello Sir. Could you kindly explain why we are adding the net premium to the minimum interest rate? I understand why we are adding it to the maximum interest rate on the put option, but why are we including it twice? Thank you for all your help.

  13. When we set a collar, we buy at a strike price. This strike price could be any price from the option given in the question or is there a way we decide on which strike price to buy at for collars.
    Help will be appreciated.
    Thank you.

    • There is no best strike price to use (fixing a ‘better’ cap or floor will cost more in terms of the premium, which may be wasted because the option is not exercised).

      Unless the question specifies differently, then ideally you would illustrate with all of the strike prices available. However the marks are mostly for proving you know how options (and collars) work and so just using one strike price would get you most of the marks.

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