2015 Sep/Dec Q2 (Interest rate collar)

JJoanne7y ago

Hi Sir, I am confused on the interest rate collar. After watching the parts of interest rate risk management, I find the answer of past paper is different to calculate gain / loss on exercise. Question: Interest rates fall to 4.1% Exercise price of Buy call 97.00 Futures price: 95.74 Exercise: No Exercise price of Sell put 96.50 Futures price: 95.74 Exercise: Yes Loss on exercise: -95,000 (76 x 25 x 50) 1. Option needs to buy call then sell put, but why the company just exercise one side? 2. IF call and put are separate to calculate, the company exercises the sell put, does it buys the call at the end? 3. Why does the company have loss on exercise? Since the company has benefit on selling put, then it exercises the option. Why does the company have loss at the end? 4. Gain / loss on exercise is the difference between Buy call and Sell put, but why does the answer use the difference between Sell put and Futures price? Thank you!

John MoffatTutor7y ago#1

I suggest that you watch my lecture on collars again!! For the call option that is purchased by the company then it is the company's choice as to whether to exercise or not. They will exercise if they will make a gain, but otherwise they will simply not exercise. However for the put option they have sold to someone else. So it is the someone else who decides whether or not to exercise. If the someone else decides to exercise because the make a gain, then it is the company (who sold it to them) who had to pay them the gain - so the company makes a loss.

JJoanne7y ago#2

Thank you for your reply!! I have watched the chapter again, I really misunderstood about CAP and FLOOR before. Is the below sentences correct? Borrow money: Buy Put option (Cap) - pay premium - choice of exercise by us Sell Call option (Floor) - receive premium - choice of exercise by buyer Deposit money: Buy Call option (Floor) - pay premium - choice of exercise by us Sell Put option (Cap) - receive premium - choice of exercise by buyer Also, no situation will exercise both Put and Call, right? And Gain / Loss is different between futures price and exercise price? Thank you for your help again!

John MoffatTutor7y ago#3

All correct :-)

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