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hi sir
i have tried attempting collar questions but it seems im not understanding the logic behind that
please correct me if im wrong
lets say that you are going to deposit $9.75 m and you fear that the interest rates on deposit is going to decrease so you going to buy a floor and sell a cap
this will eventually reduce your premium costs
lets consider the following info.
currently on the market the deposit rate is 7.5% per annum
premium costs is in annual %
calls puts
March March
91.00 1.90 0.02
91.50 1.45 0.06
92 1.04 0.13
92.50 0.68 0.24
93 0.20 0.32
93.50 0.05 0.54so when we buy the floor we will say the minimum we want to receive is 7.5%. so we will pay a premium of 0.68% ( 92.50 ) = in the table above
so when we will sell the cap, i cannot understand which rate to use???
can you kindly help me out please.
thank you so much
the information on the table was
price calls puts
91
91.50
92
92.50
93
93.50and then the other figures were the premium for the calls and puts for the month of March
Which strike price you use depends on to what extent you are prepared to limit the maximum rate to. So there are three you would consider – 91.00 (which limits the maximum to 9%); 91.50 (which limits to 8.5%); 92 (which limits to 8%).
There is no ‘rule’ as to which would be best – that is for discussion in the question. By choosing (for example) 92.00 you would be losing any benefit of the interest rate going above 8%, but on the other hand you would be receiving the higher premium of the three (0.13%). It would depend partly on how much they thought that interest rates may rise, and also to what extent they wished to reduce the net premium.
The exam you would work out all three, and then discuss as per my previous paragraph.
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