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Hi Sir,
In this question,
When calculating the effective interest rate at 3.3%, they have received an answer of 4.173%.
But sir, I got the following answerActual Borrowing 3.8
Premium 0.013
Net Interest 3.81The difference was caused by the Loss on Basis points figure. I didn’t understand the reason behind including that in the calculation.
Could you kindly explain sir?
Interest rate options are options to buy or sell interest rate futures at a fixed price. If the options are exercised there will be a gain of the difference between the exercise price and the futures price at the date they are exercised. To calculate the futures price at the date the options are exercised we have to take into account the basis, which we assume falls linearly to zero over the life of the option.
This is all explained (with examples) in my free lectures on interest rate options.
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