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Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Choosing the strikes to hedge interest rates
Hi John,
I have some confusion in choosing strike to hedge interest rates.
My logic is:
For call options = (100-strike price)-premium and choose the strike with the highest value
For put options = (100-strike price)+premium and choose the strike with the lowest value
Is my understanding right?
No. The problem is that although different strike prices will result in different maximum or minimum effective interest rates (depending on whether call or put options), the premiums will be different (and the premium is of course ‘wasted’ but will still have been paid even if the option is not exercised).
Ideally in the exam you should show the effect for each of the strike prices available (and usually these days there are only two). If you are short of time, then just showing for one of them will get more than the half marks needed (because the examiner is more concerned that you can prove you know how options ‘work’).