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while calculating option premium for answer ( b) Kaplan revision Kit did as follows
exercise price option premium
9500 45,000,000* .015* 2/12= 1125
9550 45,000,000*0.165* 2/12=12375
9600 45,000,000* 0.710%* 2/12=53250
I want to know why only 2months premium has been calculated, I know that option future contract is also of three months and FNDC require 45M for only two months,
According to the answer FNDC is using option on future, but on exchange not on OTC
Please correct me .. We should calculate the premium based on the duration of loan? Am I right?here in the case loan duration is 2months.The answer is wrong.
The premium is always calculated as though it is for 3 months (because they are options on 3 months futures).
They should have taken 3/12, not 2/12.sir if it is wrong then why answer in kaplan wrote that?
would it be correct If I do in this way?
9500 60*500,000* .015%* 3/12= 1125
9550 60*500,000*0.165%* 3/12=12375
9600 60*500,000* 0.710%* 3/12=53250but both have the same answer
I do not have the Kaplan books, and so it was difficult for me to follow without the full question.
It seems that they have just set it out very strangely.The premium should always be calculated for 3 months.
However, because using futures (and the options are on futures) protect always for 3 months of interest, the amount of futures (and therefore options) dealt in should always be the amount at risk x ((length of borrowing) / 3)
So….the way you wrote it in your last post is the way it should be written. The amount at risk is 45M. So we want to deal in 45M x 2/3 = 30M (which is 60 contracts assuming that the contract size is 0.5M)
(PS Don’t assume that Kaplan never make mistakes 🙂 They are usually correct, but neither they nor BPP nor even ourselves are always 100% perfect!!)
hello Sir,
I donot understand regarding part b that how they decided the option as a put option?
And in part c that fndc will buy put option and sell call option .how to decide that?
Moreover in part c how is the premium amt of 0.095% is calculated?If you are borrowing money then you will always buy a put option to protect against interest rates rising (if rates rise then the futures price falls – a put option gives the right to sell the future at a fixed price, so if the price has fallen you can buy and then sell the future and make a profit).
Just as buying a put option creates a cap (i.e. limits the maximum interest), selling a call option creates a floor (i.e. limits the minimum interest) and we then have a collar.
The net premium of 0.095 is the difference between the premium paid for the put option (0.165 from the table in the question) less the premium received from selling a call option (0.070 from the table).
The free lectures on interest rate options (together with the extra note on collars) will help you.
Can you please confirm me how put option strike price are calculated?
9500 9550 9600
put option strike price 5.00% 4.50% 4.00%The options are options to sell futures at a fixed price.
The equivalent futures price is 100 – interest rate.
So 5% is equivalent to a futures price (and therefore a strike price) of 100 – 5 = 95.00.
4.5% is equivalent to 100 – 4.5 = 95.50
4% is equivalent to 100 – 4 = 96.00I do suggest that you watch the free lectures on the management of interest rate risk where all this is explained in detail.
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