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In the technical article published by ACCA regarding the ‘How to answer an interest rate risk management question’ how does the exercise price change in the interest rate option ?
When IR = 4.2% ,Exercise price = 94.25
and , IR = 5.3% ,Exercise price = 95.25
Since March call options are chosen and on-call options, the highest net receipt is chosen.
The exercise price of 95.25 gives the highest receipt and the same must be chosen as per the text.
How did the change in the interest rate also affect the exercise prices of options? Is the highest ner receipt exercise price for the period of March chosen ?
Cant be able to find the answers anywhere, sir.
Please help for tomorrow.
The exercise prices to do not change.
The options are options to buy or sell interest rate futures at a fixed price, and it is the futures price that changes.
In the exam these days there are usually only two exercise prices to choose from and you should show the workings for both of them, and then discuss. One will limit the effective interest better than the other, but the other will have the lower premium (and the premium is still payable even if they do not exercise the option), so you are not usually in a position to say which of the two is best.
However if you are short of time, then just showing the workings for one of the exercise prices will get more than the half marks needed (provided, obviously, that it is clear from your workings that you understand how interest rate options work.).
They are explained in detail in my free lectures, although I appreciate that you do not now have much time given that the exam is tomorrow.