Hi Sir, thank you for your lecture. There is 1 question that I would like to ask. What if the futures price for 13th August is not given, is there another approach to answer the question?

How do we know which option to use when we are given different rates. The model answers calculate all the outcome of all the rates. Is that how we should do them?

Another great lecture sir. I would like to ask if interest rates fall below the interest rate of the option ie below 5.75, what then would happen? Would the option be sold at the end of September?

If the interest rate fell then you would just ‘throw away’ the option. Nobody would buy it from you because it would not be worth anything.

Buying an option is a bit like paying for insurance. If the interest rate goes up then you are protected (you would exercise the option) but if the interest rate goes down then you don’t use the option but pay less interest. To get the benefit of the protection you have to pay the premium at the beginning.

It depends whether you are borrowing or depositing, and what strike prices are available. There is no ‘best’ combination for a collar – the more you restrict the difference, the lower the net premium will be.
Do read my article on collars: http://opentuition.com/articles/p4/interest-rate-collars/

A put option is the right to sell a future at a fixed price (the strike price). So exercising it means buying the future at whatever the price happens to be, and immediately selling it at the strike price.

Hi there – thank you so much for these lecture. It’s really top quality. I’m just struggling with one aspect when calculating the premium on Interest Rate Options. I understand all components except for the dividing by 400. I would understand if it was just divided by 100 – and I appreciate the fact that you say it’s ALWAYS divided by 400 but why? I assume it’s related to the fact that we’re dealing with 3-month interest rate futures – is it because the premium is quoted as an annual price and needs to be divided by 4?

Maybe sometime I will record one, but there are no techniques involved that are not covered in the earlier lectures.
In addition I have recorded several lecture working through past exams questions on this (you can find them linked from the main P4 page as ‘P4 revision and past questions’.)

Thank you for your lectures, they help me a lot! Watched all of them for p4
I have the question about effective interest rate on interest rate options in the example 6.
when we calculate it we add premium to the paid amount of interest and to the gain from the option. However we paid premium in advance on ?ug 13, and other amounts on Sept 18.
Shouldn’t we consider time value of money for the premium, and use its NPV on Sept 18, to calculate effective interest rate? e.g. 7125*(1+r)? Thank you!

Yes you can, and occasionally the examiners does this in some of his answers.
However it is a minor point – the marks are mainly for proving that you understand how options work.

I have one question, though.
How was it possible to exercise the put option on Sep 18th?
They are quoted to mature at the end of Sep, i.e on Sep 30th.
Or are they American type of options?

Hello
In previous examples, when predicting the effective interest rate we added the changes in basis risk. Why do we use the premium this time?

Why did you use the 94.25 as your strike price? If we were ask to determine the most suitable strike price how would you do this? Would you assume to take the strike price closest to the LIBOR rate on the 13/08 (ie 5%) hence the strike price closest to 95.00. Or would you take 6,4% hence the strike price closest to 93,6?

Firstly, we can’t predict an effective interest rate because these are options. All we can do is determine the worst interest rate we could suffer (because if interest rates moved the other way then we would not exercise the options).

Secondly, since the premium is payable whether or not the option is exercised it makes the overall cost greater (there is no premium payable when we are simply dealing in futures rather than using options).

Thirdly, there isn’t really any such thing as a ‘best’ exercise price. This is because although different exercise prices create different ‘worst’ outcomes, for better ‘worst’ outcomes you pay a higher premium which might end up being wasted if we do not need to exercise the option. In the exam, ideally you would calculate for all available exercise prices and then discuss (which actually does not take too long – once you have done it for one it is rather repetitive). However if you are short of time, just illustrating for one exercise price (and then discussing) would get most of the marks – the marks are mainly for proving that you know how options work.

I assume that you have downloaded the free lecture notes (otherwise there is no point in watching the lectures!).

In the question is says that LIBOR is currently 5% and that Agne can borrow at 6.4%. Therefore she is paying a premium of 1.4% above LIBOR and we always assume that the premium will remain constant.

HELLO SIR JOHN
IN THIS QUESTION THERE ARE 3 STRIKE PRICES ARE GIVEN FOR PUT OPTIONS ,PRIMIUMS (NET RECIPTS)
94.25 0.19 94.06
94.50 0.21 94.29
94.75 0.48 94.27

STRIKE PRICE OF 94.50 GIVES HIGHEST NET RECIPT OF 94.29 ,WHY YOU STILL USE STRIKE PRICE OF 94.25

The problem is that although one strike price will give the best ‘limit’ it is also has the highest cost/premium (and the option might not be used depending on what he eventual interest rate actually is).

We don’t know what the eventual outcome actually will be, and therefore we need to look at all the choices of strikes and then discuss.

if there are 3 strike prices given in the exam,we must have to demonstrate maximum cap of each strike price given ! and there relevent premiums, then we chose which ever seems best and compute our answers !

if there are 3 strike prices given in the exam,we must have to demonstrate maximum cap of each strike price given ! and there relevent premiums, then we chose which ever seems best and compute our answers !

Although most of the marks are for proving that you understand how options work, ideally (subject to how much time you have available) you should look at all the strike prices and then discuss.
As I wrote before, it is rare that you can say that any one of them is definitely the best (if interest rates fall and we don’t exercise the option then the one with the lowest premium would be best, but if interest rates go up then the one with the lowest maximum would be best, but obviously we do not usually know what is going to happen in the future) – it is more a question of discussing in the exam, and again proving that you understand how they work.

The current futures price has do direct relevant (because we will only deal in the futures if we exercise the option and the trade will take place on the date we exercise the option).

However, in exams we will usually need to know the current futures price (and the current basis) in order to be able to calculate what the futures price will be on the date the option is exercisable.

In the last part of the video where we calculate the prediction of maximum rate, you say that we cannot say which is the better of the two option between strike 94.25 and 94.50.

But since we calculated that the total maximum cap. for 94.50 is 7.11% which is lower than the maximum cap. of 94.25 which is 7.34%, wouldn’t we be allowed to say that strike price of 94.50 is better since our payable of maximum interest rate is cap at a lower rate of 7.11%?

Noted in a technical article on interest rate risk management a question on Titans FC that the LIBOR 6% translating to 94 and the futures price is also the same 94 on today’s date ie 15th Dec….. how can we calculate the futures price on its maturity?

Great lecture but I am still not clear on the basis for choosing a strike price. In exam conditions, should we just go with the strike price that has the lowest premium as a rule?

Ideally you should illustrate for all the strike prices. If you do not have time then illustration with just one will get the majority of the marks. The main thing is to prove you know how options work.

In example 6 the option is exercised on 18th September. But I thought that European options can only be exercised at the end of the month they are referred to by. So how does this work in practice? Many thanks, these lectures are so helpful.

It is true that european options can only be exercised at the end of the month.
However, since they are traded options, then way it works in practice is that you sell the option 🙂

In this example, we were told that Agne wanted to use the strike price of 94.25. What if in exam, the question asks as to choose an option that would be most effective?? Do we solve the question by using all 3 strike prices or can we advise by calculating the maximum effective interest rate???

Choose a strike price that is close to the current LIBOR. The BPP text book says and I quote: ‘Make sure you read the question carefully to determine whether you have been told which strike price to use. If you have not been told you can choose the strike price closest to the interest rate – for example if the interest rate is 3% then you would choose an exercise price of 97.00.’ I hope this helps.

Ok. thanks. So just to be sure… SUPPOSE in Agnes example. we werent told which strike price to use, then as the current LIBOR given in the example is 5%, then we would have used strike price of 94.75, as that is closest to the current LIBOR??? Correct?

And what about Currency options?? Do we use the same point of using the exercise price nearest to spot rate or is there some other way?? In BPP book, it adds/subtracts premium from call/put option to arrive at a net and then decides which one to chose based on the most favorable.?? Thank u.

@Johnmoffat am so thankful for providing us with these free lectures. They are sooo helpful especially here in New Zealand where we don’t have lecturers for optional papers, so these lectures are my only hope.
I have a question concerning Q.5 of December 2008, we have been given the futures open and settlement prices. Which of these two do we use when calculating basis? I know we use the current LIBOR, but which futures price do I use, open or settlement? And why?

The current basis (on 13 August) is the difference between the current spot rate, and the current price of the September future (which is 94.30).
As the spot rate changes, so to the price of the futures – we can estimate by assuming that the basis (the difference) falls linearly.

94.25 is an exercise price (not a futures price). All it means is that if we choose to exercise the option then we have the right to buy or sell (depending whether put or call) a future at that fixed price. We would only exercise if we would make a profit, and the profit will be the difference between whatever the futures price is on that date, and the exercise price.

It is said in the course of lecture while counting broken period days for option that August has got 30 days. Does it mean that we have to count 30 days uni formally by taking into account 360 days in a year.. Or we have to count actual number of days in that case From August 13 to August 31 , they are coming 18 days. Kindly clarify.

Dear Sir
My purpose was to get clarity about counting number of days. It is very good lecture.
You are doing very nobal job in making available such a quality stuff at free of cost across globe.
God bless

Very nice lecture.
My only doubt is that it was told in the course of lecture that August has got 30 days so while counting days from August 13 it was taken as 17 days for August + 30 days for September.
On this background
1) Since August has 31 days actually but for the sake of calculation should we be presuming that Year has got 360 days and every month ( including February) has got 30 days invariably
2) If not by taking into account actual number of days in August it becomes 18 days in August + 30 days in September.
Can you kindly throw light on this.

Very nice lecture. Only one doubt -it was said during the course of lecture that while counting days for August that August has 30 days so remaining days in August being 17 + 30 for September. My doubt is
1) Should we be assuming 360 days in a year and uniform 30 days in every month while counting the days for Interest Rate Options. or
2) We have to take actual number of days in that case it would have been 18 days in August from August 13 , leaving 13 and counting remaining 18 days.
Please throw light on it.
Apart from this excellent lecture. God bless.

Sorry, but there is one more confusion.
How to find strike/exercise price in Interest option?
Will it be 100 – (current libor)
Or
It will be 100 – (maximum borrowing rate borrower is ready to pay)

In examples we took exercise price as 94.25 (100-5.75)
But in December 2008 question of PHOBUS CO. exercise price is not 100-6.6.

I’m a bit confused. In last lecture we estimated future price by subtracting future interest rate from 100, that was 85(100-15).
Why don’t we do the same in this question? Why can’t we calculate future price by subtracting LIBOR of 6.5% from 100 to find the future price.
I mix both the methods. Kindly tell me when to use which one.
Thank you.

The previous question was a ‘baby’ example to explain the principle.

In practice the futures price will not be ‘perfect’ – i.e. it will not be exactly 100 – the interest rate. The difference between the actual futures price and the ‘perfect’ price is the basis risk – we assume that this difference falls to zero by the end of the future.

Hi thanks for such a clear lectures! but i have one question
As the cost of selling additional contract is less than benefit from this contract on 18 September, why should we limit the number of contract to 30?
Is it becouse we take this desicion on 13th of August?

For example 7 of this chapter it asks to how Agne could use a collar to hedge.

How is the hedge effectivness calculated if we’ve sold september call options that are exerciseable upto September 30 and our own transactions end on September 18.

Is the hedge efficieny and effective interest rate only calcuable until after September 30 when the options expire?

@htung00, If the options are American style, then they can be exercised at any time up to the end of the relevant month. If they are European style then they can only be exercised at the end of the month (but they could be sold earlier at whatever the price happened to be on the date of sale).

@johnmoffat, in example 7 we bought put options and sold call options to create a collar. With the put options we can sell them anytime, but my problem is with the call options we sold.

They once sold we have no control of when it is exercised we where able to calculte the profit from selling the put options on 18 sept but we still wouldn’t know the complete effect of the call options as there is still oppurtunity for loss until sept 30

lectures on int rate risk mgmt were very helpful to me cuz i had no access to physical tutor in town. Thanks OT.

I’ve a particular question on this Int rate option (2) lecture. In the end, lecturer says its hard to decide amongs strike prices 94.25 and 94.50. I understood the calculations but what’s the logic in avoiding selecting the best strike price. Can anyone tell me?

did you succeed in June or you have to retake it?
Now in December it will be my second attempt…
the June exam was really tough, or i was not prepared enough…
Good Luck to you!

Jake says

Hi Sir, thank you for your lecture. There is 1 question that I would like to ask. What if the futures price for 13th August is not given, is there another approach to answer the question?

Chris says

Hi John,

If we were asked to calculate the hedging efficiency for this type of hedge would it be:

34,875-7,125/400,400 x 100% = 69.3%

or would we ignore the cost the premium:

34,875/400,400 x 100% = 87.1%

Many thanks,

Chris

John Moffat says

You wouldn’t be asked for the hedging efficiency 🙂

mosko1 says

How do we know which option to use when we are given different rates. The model answers calculate all the outcome of all the rates. Is that how we should do them?

John Moffat says

There is no ‘best’ strike price and so ideally you should show the calculations for all of them.

Nicholas says

Another great lecture sir. I would like to ask if interest rates fall below the interest rate of the option ie below 5.75, what then would happen? Would the option be sold at the end of September?

John Moffat says

If the interest rate fell then you would just ‘throw away’ the option. Nobody would buy it from you because it would not be worth anything.

Buying an option is a bit like paying for insurance. If the interest rate goes up then you are protected (you would exercise the option) but if the interest rate goes down then you don’t use the option but pay less interest. To get the benefit of the protection you have to pay the premium at the beginning.

Nicholas says

Understood sir 🙂

John Moffat says

You are welcome 🙂

omotayo says

Good morning,

Please under interest rate collar what is the bases for selecting the strike price to the used for the put and call option

John Moffat says

It depends whether you are borrowing or depositing, and what strike prices are available. There is no ‘best’ combination for a collar – the more you restrict the difference, the lower the net premium will be.

Do read my article on collars:

http://opentuition.com/articles/p4/interest-rate-collars/

Kit Sophal says

Dear sir,

thanks for your clear lecture. I am not sure why we sell at strike price because this is put option. Do i miss something?

Best Regards

John Moffat says

A put option is the right to sell a future at a fixed price (the strike price). So exercising it means buying the future at whatever the price happens to be, and immediately selling it at the strike price.

Carel says

Hi there – thank you so much for these lecture. It’s really top quality. I’m just struggling with one aspect when calculating the premium on Interest Rate Options. I understand all components except for the dividing by 400. I would understand if it was just divided by 100 – and I appreciate the fact that you say it’s ALWAYS divided by 400 but why? I assume it’s related to the fact that we’re dealing with 3-month interest rate futures – is it because the premium is quoted as an annual price and needs to be divided by 4?

John Moffat says

I do explain this in my lectures. You divide my 100 because it is a %, and you divide by 4 because they are three months futures.

cyh says

hi Sir, can u please upload the answer for example 7?

John Moffat says

I will at some stage, but for the moment there is a detailed note on collars that is linked from the main P4 page.

cyh says

noted. will wait for your answer as wanna know the step by step answer

John Moffat says

OK 🙂

yaseen says

why is der any lecture on business valuation .?

John Moffat says

Maybe sometime I will record one, but there are no techniques involved that are not covered in the earlier lectures.

In addition I have recorded several lecture working through past exams questions on this (you can find them linked from the main P4 page as ‘P4 revision and past questions’.)

Alma says

Thank you for your lectures, they help me a lot! Watched all of them for p4

I have the question about effective interest rate on interest rate options in the example 6.

when we calculate it we add premium to the paid amount of interest and to the gain from the option. However we paid premium in advance on ?ug 13, and other amounts on Sept 18.

Shouldn’t we consider time value of money for the premium, and use its NPV on Sept 18, to calculate effective interest rate? e.g. 7125*(1+r)? Thank you!

John Moffat says

Yes you can, and occasionally the examiners does this in some of his answers.

However it is a minor point – the marks are mainly for proving that you understand how options work.

Alma says

thank you!

John Moffat says

You are welcome 🙂

Jeffery says

Hello !!! I want to say that there should be 31days in august not 30 days.

John Moffat says

So there are! 🙂

Alma says

Haha- I also calculated 17 days in August in this example)))

tinicaa says

September future price in August was 94.3 or 94.25? what did i miss here? did you just round off?

John Moffat says

You can see from the question that the futures price was 94.30.

It is the option that has a strike price of 94.25.

aliimranacca007 says

Dear sir why we use strike price 94.25 we can sale 13 august future price which is 94.30 by doing this we pay less interset ?

neustrdm says

Thank you a lot for your lecture

I have one question, though.

How was it possible to exercise the put option on Sep 18th?

They are quoted to mature at the end of Sep, i.e on Sep 30th.

Or are they American type of options?

Best regards,

Dmitry

John Moffat says

In the exam you effectively do assume that they are American style.

(In practice, even though you cannot exercise European style options early, what you can do is sell the option which will have the same effect.)

rouquinblanc says

hello

example 7 chapter 20 has no answers at the back. Could you please advise?

thank you

John Moffat says

No there isn’t and I must add an answer.

However, I have written a full explanation of how collars work – you can find it linked from the main P4 page.

rouquinblanc says

Hello

In previous examples, when predicting the effective interest rate we added the changes in basis risk. Why do we use the premium this time?

Why did you use the 94.25 as your strike price? If we were ask to determine the most suitable strike price how would you do this? Would you assume to take the strike price closest to the LIBOR rate on the 13/08 (ie 5%) hence the strike price closest to 95.00. Or would you take 6,4% hence the strike price closest to 93,6?

Thank you

John Moffat says

Two things.

Firstly, we can’t predict an effective interest rate because these are options. All we can do is determine the worst interest rate we could suffer (because if interest rates moved the other way then we would not exercise the options).

Secondly, since the premium is payable whether or not the option is exercised it makes the overall cost greater (there is no premium payable when we are simply dealing in futures rather than using options).

Thirdly, there isn’t really any such thing as a ‘best’ exercise price. This is because although different exercise prices create different ‘worst’ outcomes, for better ‘worst’ outcomes you pay a higher premium which might end up being wasted if we do not need to exercise the option. In the exam, ideally you would calculate for all available exercise prices and then discuss (which actually does not take too long – once you have done it for one it is rather repetitive). However if you are short of time, just illustrating for one exercise price (and then discussing) would get most of the marks – the marks are mainly for proving that you know how options work.

rouquinblanc says

thank you very much

John Moffat says

You are welcome 🙂

Sara says

Is Agne premium of 1.4% given in qn?

John Moffat says

I assume that you have downloaded the free lecture notes (otherwise there is no point in watching the lectures!).

In the question is says that LIBOR is currently 5% and that Agne can borrow at 6.4%. Therefore she is paying a premium of 1.4% above LIBOR and we always assume that the premium will remain constant.

kakataj says

HELLO SIR JOHN

IN THIS QUESTION THERE ARE 3 STRIKE PRICES ARE GIVEN FOR PUT OPTIONS ,PRIMIUMS (NET RECIPTS)

94.25 0.19 94.06

94.50 0.21 94.29

94.75 0.48 94.27

STRIKE PRICE OF 94.50 GIVES HIGHEST NET RECIPT OF 94.29 ,WHY YOU STILL USE STRIKE PRICE OF 94.25

KINDLY EXPLAIN …I AM STUCK

John Moffat says

Please do not type in capital letters.

The problem is that although one strike price will give the best ‘limit’ it is also has the highest cost/premium (and the option might not be used depending on what he eventual interest rate actually is).

We don’t know what the eventual outcome actually will be, and therefore we need to look at all the choices of strikes and then discuss.

kakataj says

sorry about that..

so please correct me if i am wrong

if there are 3 strike prices given in the exam,we must have to demonstrate maximum cap of each strike price given ! and there relevent premiums, then we chose which ever seems best and compute our answers !

kakataj says

sorry about that..

so please correct me if i am wrong

if there are 3 strike prices given in the exam,we must have to demonstrate maximum cap of each strike price given ! and there relevent premiums, then we chose which ever seems best and compute our answers !

John Moffat says

Although most of the marks are for proving that you understand how options work, ideally (subject to how much time you have available) you should look at all the strike prices and then discuss.

As I wrote before, it is rare that you can say that any one of them is definitely the best (if interest rates fall and we don’t exercise the option then the one with the lowest premium would be best, but if interest rates go up then the one with the lowest maximum would be best, but obviously we do not usually know what is going to happen in the future) – it is more a question of discussing in the exam, and again proving that you understand how they work.

jigsaw1992 says

do the futures price on 13 august have no use here in then??

John Moffat says

The current futures price has do direct relevant (because we will only deal in the futures if we exercise the option and the trade will take place on the date we exercise the option).

However, in exams we will usually need to know the current futures price (and the current basis) in order to be able to calculate what the futures price will be on the date the option is exercisable.

davisyieh says

Hi Sir,

In the last part of the video where we calculate the prediction of maximum rate, you say that we cannot say which is the better of the two option between strike 94.25 and 94.50.

But since we calculated that the total maximum cap. for 94.50 is 7.11% which is lower than the maximum cap. of 94.25 which is 7.34%, wouldn’t we be allowed to say that strike price of 94.50 is better since our payable of maximum interest rate is cap at a lower rate of 7.11%?

John Moffat says

It certainly will end up better if interest rates go up.

However, the problem is that it costs more and so if interest rates fall then we will have ‘wasted’ more money.

Options are attractive if you think interest rates will fall, but you want protection (‘insurance’) in case you are wrong and they increase.

mwende1 says

Noted in a technical article on interest rate risk management a question on Titans FC that the LIBOR 6% translating to 94 and the futures price is also the same 94 on today’s date ie 15th Dec….. how can we calculate the futures price on its maturity?

John Moffat says

In the article, the futures price is not 94 !!

The price on 15 December of March futures is 93.790.

So the basis is 94 – 93.790 and we assume that this falls to zero over the life of the future.

sogan0 says

IS THIS IT? NO MORE LECTURES IM SAD

John Moffat says

What more lectures are you wanting? 🙂

(and there is one more after this one on interest rate swaps)

sogan0 says

when? I so enjoyed all the lectures if I don’t pass this exam it will be all my fault. Excellent lectures!

John Moffat says

Thank you 🙂

sogan0 says

When? Thank You for your excellent lectures!

annette says

Wow John you are a truly gifted, you make P4 seem so easy to understand and having used F9 and passed this registered so quickly…..many thanks.

Will you be posting lectures on SWAPS?

Thank you again!

John Moffat says

There is now a lecture on swaps 🙂

vinukmathews says

Tnxs admin,

where can i find lecture videos for swaps

John Moffat says

Sorry but there is not yet a lecture on swaps.

demashi says

Hi John,

Great lecture but I am still not clear on the basis for choosing a strike price. In exam conditions, should we just go with the strike price that has the lowest premium as a rule?

John Moffat says

Ideally you should illustrate for all the strike prices. If you do not have time then illustration with just one will get the majority of the marks. The main thing is to prove you know how options work.

hezz says

In example 6 the option is exercised on 18th September. But I thought that European options can only be exercised at the end of the month they are referred to by. So how does this work in practice? Many thanks, these lectures are so helpful.

John Moffat says

It is true that european options can only be exercised at the end of the month.

However, since they are traded options, then way it works in practice is that you sell the option 🙂

uzair says

u didnt use ref point in this example… 🙂

kay says

Question 2 of December 2013 was unbelievable! All thanks to you John Moffat, you are the best!

hssniqbl says

In this example, we were told that Agne wanted to use the strike price of 94.25. What if in exam, the question asks as to choose an option that would be most effective?? Do we solve the question by using all 3 strike prices or can we advise by calculating the maximum effective interest rate???

kay says

Choose a strike price that is close to the current LIBOR. The BPP text book says and I quote: ‘Make sure you read the question carefully to determine whether you have been told which strike price to use. If you have not been told you can choose the strike price closest to the interest rate – for example if the interest rate is 3% then you would choose an exercise price of 97.00.’ I hope this helps.

hssniqbl says

Ok. thanks. So just to be sure… SUPPOSE in Agnes example. we werent told which strike price to use, then as the current LIBOR given in the example is 5%, then we would have used strike price of 94.75, as that is closest to the current LIBOR??? Correct?

hssniqbl says

And what about Currency options?? Do we use the same point of using the exercise price nearest to spot rate or is there some other way?? In BPP book, it adds/subtracts premium from call/put option to arrive at a net and then decides which one to chose based on the most favorable.?? Thank u.

kay says

@Johnmoffat am so thankful for providing us with these free lectures. They are sooo helpful especially here in New Zealand where we don’t have lecturers for optional papers, so these lectures are my only hope.

I have a question concerning Q.5 of December 2008, we have been given the futures open and settlement prices. Which of these two do we use when calculating basis? I know we use the current LIBOR, but which futures price do I use, open or settlement? And why?

John Moffat says

You should use the settlement prices.

(Open is the price at the start of the day, settlement is the average price for the day)

I would not worry too much about this. The question you are referring to was set by the old examiner who was replaced 🙂

kay says

Oh how nice! Thank you so much.

rmracca says

Hi Tutor ,

Thanks for the lectures on interest rate risk management .

I was wondering if lectures are available for Swaps ?

Many thanks,

John Moffat says

At the moment, I am afraid that there is not a lecture.

I will record one in the future, but it will have to wait until I have a break from teaching.

rmracca says

Thanks a lot for your reply. Hope to watch the new lecture soon :).

ferrischan says

Hi how come we are using current future price in calculating the basis as 94.30 and not 94.25?

John Moffat says

The current basis (on 13 August) is the difference between the current spot rate, and the current price of the September future (which is 94.30).

As the spot rate changes, so to the price of the futures – we can estimate by assuming that the basis (the difference) falls linearly.

94.25 is an exercise price (not a futures price). All it means is that if we choose to exercise the option then we have the right to buy or sell (depending whether put or call) a future at that fixed price. We would only exercise if we would make a profit, and the profit will be the difference between whatever the futures price is on that date, and the exercise price.

deepmaharaj says

It is said in the course of lecture while counting broken period days for option that August has got 30 days. Does it mean that we have to count 30 days uni formally by taking into account 360 days in a year.. Or we have to count actual number of days in that case From August 13 to August 31 , they are coming 18 days. Kindly clarify.

John Moffat says

Ooops – there are 31 days in August. I made a mistake – sorry.

However 1 day will not make any real difference so I am not too worried 🙂

deepmaharaj says

Dear Sir

My purpose was to get clarity about counting number of days. It is very good lecture.

You are doing very nobal job in making available such a quality stuff at free of cost across globe.

God bless

deepmaharaj says

Very nice lecture.

My only doubt is that it was told in the course of lecture that August has got 30 days so while counting days from August 13 it was taken as 17 days for August + 30 days for September.

On this background

1) Since August has 31 days actually but for the sake of calculation should we be presuming that Year has got 360 days and every month ( including February) has got 30 days invariably

2) If not by taking into account actual number of days in August it becomes 18 days in August + 30 days in September.

Can you kindly throw light on this.

deepmaharaj says

Very nice lecture. Only one doubt -it was said during the course of lecture that while counting days for August that August has 30 days so remaining days in August being 17 + 30 for September. My doubt is

1) Should we be assuming 360 days in a year and uniform 30 days in every month while counting the days for Interest Rate Options. or

2) We have to take actual number of days in that case it would have been 18 days in August from August 13 , leaving 13 and counting remaining 18 days.

Please throw light on it.

Apart from this excellent lecture. God bless.

coolsara says

It went over my head 🙁

sehrikhan says

Sorry, but there is one more confusion.

How to find strike/exercise price in Interest option?

Will it be 100 – (current libor)

Or

It will be 100 – (maximum borrowing rate borrower is ready to pay)

In examples we took exercise price as 94.25 (100-5.75)

But in December 2008 question of PHOBUS CO. exercise price is not 100-6.6.

sehrikhan says

I’m a bit confused. In last lecture we estimated future price by subtracting future interest rate from 100, that was 85(100-15).

Why don’t we do the same in this question? Why can’t we calculate future price by subtracting LIBOR of 6.5% from 100 to find the future price.

I mix both the methods. Kindly tell me when to use which one.

Thank you.

John Moffat says

The previous question was a ‘baby’ example to explain the principle.

In practice the futures price will not be ‘perfect’ – i.e. it will not be exactly 100 – the interest rate. The difference between the actual futures price and the ‘perfect’ price is the basis risk – we assume that this difference falls to zero by the end of the future.

sehrikhan says

Thank you 🙂

azinbu says

Hi thanks for such a clear lectures! but i have one question

As the cost of selling additional contract is less than benefit from this contract on 18 September, why should we limit the number of contract to 30?

Is it becouse we take this desicion on 13th of August?

John Moffat says

@azinbu, Yes – it is because the decision has to be made ‘now’.

zains says

arent there lectures on forex swaps and interest rate swaps?

htung00 says

For example 7 of this chapter it asks to how Agne could use a collar to hedge.

How is the hedge effectivness calculated if we’ve sold september call options that are exerciseable upto September 30 and our own transactions end on September 18.

Is the hedge efficieny and effective interest rate only calcuable until after September 30 when the options expire?

John Moffat says

@htung00, If the options are American style, then they can be exercised at any time up to the end of the relevant month. If they are European style then they can only be exercised at the end of the month (but they could be sold earlier at whatever the price happened to be on the date of sale).

htung00 says

@johnmoffat, in example 7 we bought put options and sold call options to create a collar. With the put options we can sell them anytime, but my problem is with the call options we sold.

They once sold we have no control of when it is exercised we where able to calculte the profit from selling the put options on 18 sept but we still wouldn’t know the complete effect of the call options as there is still oppurtunity for loss until sept 30

John Moffat says

@htung00, Good point – I will have to think about it. In theory you could buy back the options though.

bowe says

Very helpful. Thanks a lot.

accaforall says

Thanks

mrxamag says

RESPECT O.T.

sushilp says

lectures on int rate risk mgmt were very helpful to me cuz i had no access to physical tutor in town. Thanks OT.

I’ve a particular question on this Int rate option (2) lecture. In the end, lecturer says its hard to decide amongs strike prices 94.25 and 94.50. I understood the calculations but what’s the logic in avoiding selecting the best strike price. Can anyone tell me?

raed68 says

It stops at the minute 7.27

goodnewskydzramedo says

i actually now get the reasoning behind futures and options. i am pretty sure it would be one of my questions to answer should it show up in the exams

I am predicting international investment appraisal to be there as it’s been quite sometime now since it’s been examined. Any tips

anneliese464 says

did you succeed in June or you have to retake it?

Now in December it will be my second attempt…

the June exam was really tough, or i was not prepared enough…

Good Luck to you!

wedson says

this was an eye opener to me on the points i was missing especialy on whether to buy/sell futures & option contracts