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John Moffat.
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- April 11, 2015 at 7:04 pm #240939
Asteroid Systems: Can you tell me what do the 1.4% and 1.6% under the heads One month and three month respectively mean?
Phobos Co: Can you tell me what will be the Lock in rate for Interest Rate Futures, mine (5.08%) is different from the Effective Rate / Annual Equivalent (5.68%)
I also wanted to ask that wouldn’t using the Exercise price of 94250 be better than using 94000 since the Effective rates would be 6.51% (for 94250) than 5.63% (for 94000)?
April 12, 2015 at 10:43 am #240997Asteroid:
It is the % change in the midpoint. So for 1 month it is ((1.6242 – 1.6223) / 1.6242) x 12
For 3 months it is ((1.6242 – 1.6176) / 1.6242) x 4(Although I would not worry about this particularly – it has only happened once and it was the previous examiner. I do not think the new examiner would do this.)
Phobos:
The lock-in rate is 93.88 + 0.04 = 93.92, which is equivalent to 6.08%, plus 50 basis points = 6.58% (which is the same as the annual equivalent, which is 6.58% (not 5.68%)).
(Alternatively, the lock-in rate is 94.00 – 0.08 = 93.92 – either way always gives the same answer)Since they are borrowing money, the would want the effective rate to be as low as possible.
April 13, 2015 at 7:47 pm #241178But isn’t the 94250 strike price better than 94000?
April 14, 2015 at 7:28 am #241235On its own maybe, but there is also the premium to take into account. You wrote yourself that the effective rate is lower for 94000 at 5.63%
April 14, 2015 at 3:44 pm #241283Its my mistake, I misstated the rates in my post.
The Interest Rate achieved (after taking into account all Premiums and Gains) with both Ex Prices are:
94000 = 6.63%
94250 = 6.51%
(In the situation where Interest Rates move against our favor)Examiner used 94000 whereas 94250 was much favorable for us? (We are borrowing)
April 14, 2015 at 5:34 pm #241295The answer is in fact very poor for several reasons.
One is that looking at an average interest rate is meaningless.
If they do choose an exercise price of 94.00 then the effective interest rate will be either 6.63% or 5.67% depending on whether the interest goes up or down.
The answer should also have considered an exercise price of 94.25 as well, in which case the effective interest would be either 6.51% or 5.55%,
It is not really possible to say which is better because although on the one hand 94.25 gives a lower maximum interest, it costs more in premium and if interest rates were to fall by more than 1% (say 2% or 3%) then neither option would be exercised but more premium would be payable with an exercise price of 94.25.
However, one terribly important thing that the answer does not mention is the aim stated in the question of keeping the effective interest below 6.6%. An exercise price of 94.25 will achieve that, whereas 94.00 will not quite achieve it if interest rates go up.
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