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Dear John.
in Ex 3 of using trader options to hedge aginst risk of USD 1,000,000 you ende d up with a net positoin of paying GBP 683,127 …and i fully understand how these numbers came ..
but i tried a slightly different way of thinking ..i dont know if my way is the other solution way u were talking about in ur recording because i still cannot find this way even at the solution bank at the end of notes…however my process is as follows:
1- we already bought the right to sell 22 options each of GBP 31,250 at a rate of 1.475 which gives us if excersieed in april an amount of USD 1,014,062.5. (22*31,250= 687,500 Pound).
2- But from the question we need only USD 1,000,000 thus we already have an excess of USD 14,062. ok??
3- we take these USD 14,062 and convert them to pound at spot rate which is 1,4120 this gives us GBP 9,959
4- we have to pay GBP 5,556 for options premium (calculted in ur example)//
5- Combing these figures together gives us the following: 687,500 (pay)- 9,952(rec)+ 5,556 (Pay) = GBP 683,097 which is different than ur result 683, 127 .
can u plz explain…regards
Two things…..
Firstly, there is a tiny arithmetic mistake in your step 5. The net result should be GBP 683104 (not 683097).
Secondly, there is still a slight difference in the answer from the other approach. The difference is GBP 23.
The reason is that effectively the other approach is converting everything at 1.4100 whereas in this approach the USD 14062 is converted at 1.4120. The difference if the 14062 is converted at 1.4100 is GBP 23 – this is what is causing the difference.
The rate that you have used in this approach is correct.The fact that it gives a slightly different answer does not matter in the exam – either approach would get full marks.
Thank you for your reply…i was wondering if this way i used is the same other approach u were mentioning in ur recording (u mention that there is other solution found at solution in the notes) but when i turned to notes i foudn that the solution is the same as u explained in recording…is that all or still there is a third approach i didnt figure out..
thank u
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