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Dear John,
Please explain how they calculate 0.52 value of option loss in Collars and premium of 0.07 if the intrest rate decrease to 2.8 %.
John there is no answers given of example 7 of Chapter 20 in course notes related to interest rate collars.I solve it but dnt know whether its right or wrong. Can you please explain lil bit of solution related to example 7 ?
Thanks in advance.
Since they have sold a call at a strike price of 96.5 (or 3.5%), if interest rates fall to 2.98% then the buyer of the call will exercise the option and therefore we will have to pay them the difference (3.5% – 2.98% = 0.52%).
With regard to the premium, we have bought a put on which the premium we pay is 0.163. We have also sold a call and therefore receive a premium of 0.090.
So the net premium is 0.163 – 0.090 = 0.073
I will do an answer to example 7 when I have the time. However, have you read my note on interest rate collars?
https://opentuition.com/articles/p4/interest-rate-collars/
John one more thing in solution examiner only calculate the net cost of loan for the option exercised, but didnt calculate net costs of loan for options which are not exercised.So my question is we have to do same like this in exam or have to calculate net cost for all options. Please advise on that.
yah john i read and understand your every notes, but john i was worried about how to apply thats knowledge on Collar questions thats why i asked about that example 7 answers explanation from you. Well i understands that and really thanks a lot 🙂
But he has calculated in the net cost of the loan (in % terms) whether or not the options are exercised.
The net cost is the actual interest, plus the cost of the options (the premium), plus the gain on the options (if they are exercised – if they are not exercised then there is no gain on the options).
Thank you so much John.
You are welcome 🙂