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Thank you for an amazing video on interest rate risk. However can you please explain the below points :
1. if 500,0003 months future contract is mentioned in question and the funds are deposited for 6 months how do we prorate the interest and calculate the premium.Is the below correct:
Premium*500000*6/12*No of contacts
2. Also in BPP KIT Ques 51 Massie b part the solution for collars seems confusing can you please help.
how do they select the rates for call and put option.
I will be really thankful to you.
1. The interest is calculated as 6/12 of the annual interest. The premium and the gain or loss on the futures is multiplied by 6/3 because the deposit is for 6 months and they are 3 month futures.
I don’t know if you have watched all the lectures on interest rate risk, because I do go through this in the lectures.
2. In Massie they are depositing money and therefore for the collar they will buy a call option so as to limit the minimum interest rate and sell a put option which limits the maximum interest rate. Given that the are only the two exercise prices available, the collar can only be buying a call option at 97.00 which limits the minimum interest rate to 3% and selling a put option at 96.50 which limits the maximum interest rate to 3.5%. Doing anything else would not make any sense.