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Sir, the bpp kit answer directly takes the interest rate as opposed to how we calculate effective annual interest rate on options,I tried how we calculate effective annual interest rate by calculating the borrowing cost,premium,loss on options as a percentage to the loan amount (not multiplied by 12 months as the question requires annual rate),but got a slightly different answer.Should i always stick to adding interest directly method for collars?And also why is that both methods give the same answer for other questions but not for this question?
The BPP answer is a copy of the examiners own answer 🙂
I am not 100% clear as to what it is that you have done. However if the difference is only slightly different then I would not worry about it. The marks for this sort of question are not for the final answer but for proving that you basically understand how different types of hedging ‘work’.
Sir,if base rate rises by .4% to 4.1%, i calculated borrowing cost 2.208 million (48 million *4.6%) + premium (576 contracts * 1 million*.013 premiun)/400=2.2267 million
Effective annual interest rate=2.2267/48*100=4.64%
Bpp answer 4.61%
Bpp takes interest rates directly for this collar question, how to know which method to use?should all collar question be done with directly taking the interest rate?
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