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Dear Sir
In the question Alecto Co, part b, Company needs to hedge 36.67 contracts which is rounded to 37 contracts. Is there any impact on the total hedging cost due to the round (from 36.67 to 37 contract)?
Thanks,
Dear Sir,
One more question, also in part b when using collar, the solution show “buy June put at 96.00 for 0.163 and sell June call at 96.50 for 0.090. Why do they select this call/put this way? any rule to select call/put for collar? if i select buy June put at 96.00 and sell June call at 96.00, any issue?
THanks,
rounding off no of contract will lead to “Contract size Limitation”. Further, contract size Limitation will lead to Under/Overhedge. particularly in this question you will get a over hedge as you are rounding off to a higher value than the actual contract nos.
Further to your second question. Collar is a strategy which sets a Maximum and Minimum Limit for the Interest rate movement. For this purpose, we need to Buy Put option to set a Maximum Interest rate and Sell Call option to set a Lower interest rate. in this particular question the examiner has taken 4% ( 100-96 ) as a Maxmimum Interest rate and 3.5% (100-96.50) as Minimum Interest rate.
In-case if you select June Put and Call as a same exercise price 96 ( 100-4 ) then tell me what is the maximum interest rate and Minimum interest rate.?????? then you are deviating from Collar hedging principles. In summary, please remember Collar talks about maximum interest rate and Minimum interest rate. Hope this is helpful to some extent. The Tutor will also help you further . Thnx
Dear Nnithal123,
Thank for your explaination. I need to make clear the first question. In the solution, the net cost is the cost of borrowing and gain/loss on futures market. I don’t see the impact of under/over hedge so why do we ignore under/over hedge in this calculation?
Thanks,
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