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Hi,
I’ve never posted on here before but I really need help for my upcoming P4 exam.
I am completely baffled by the use of a collar on question 2b) page 7 of this pdf from the acca’s website:
https://www.accaglobal.com/content/dam/ACCA_Global/Students/prof/p4/Exam%20docs/d15_hybrid_p4_q.pdf
The solution is on page 6 of the below pdf:
https://www.accaglobal.com/content/dam/acca/global/PDF-students/acca/p4/exampapers/P4_2015_dec-a.pdf
I understand that we are looking to reduce the risk of interest rates falling on interest we are going to receive for investing 25m Euros so we purchase a call option and purchase a put which can sell to complete the collar.
But why does the solution suggest we buy the call @ 97 so 3% interest and the put @ 96.5 so 3.5% interest.
I don’t understand why we don’t buy the call @ 96.5 so 3.5% interest and the put @ 97 so 3% interest. So we can be guaranteed to receive 3.5% interest of 3% interest????
Cheers,
Firstly, options do not guarantee a fixed interest. They fix the maximum (or minimum interest).
Secondly, when creating a collar, we do not buy a put and a call option ever.
We buy one and sell the other (which one we buy depends on whether we are borrowing or depositing).It will help you to read my article on collars which you can find here:
https://opentuition.com/articles/p4/interest-rate-collars/please, sir for a interest rate collars,my understanding is that if we are investing money, we buy call option at on exercise price and sell put option at another exercise price. pls,
1.does it matter which strike price we choose to buy call or sell put option?
2-if yes how are we to go about it.
thanksIt depends on the question.
Normally it is sufficient just to create one collar in order to prove you know how they work.
That is what the examiner is testing – that you understand what collars are and how they work.Thanks and that means in sep/dec 2015 exam i wont lose any mark if choose opposite of the exercise prices the the examiner used for call and put option ?
If you really do mean the opposite (i.e. buy a put at 97.00, and selling a call at 96.50) then you would lose a lot of the marks – it would not be a collar!!!
You would be limiting the maximum rate at 3% and the minimum rate at 3.5% which would be complete nonsense.
No, I don’t mean that sir, may be I did not put it right.what I mean is buy call at 96.50 and and sell put at 97 instead of buy call at 97 and sell 96.50 as written by the examiner. Does the choice of which exercise price to buy call which to sell put matter? Thanks
But no – there are only 2 strike prices given in the question and the only way of fixing a minimum and maximum interest rate using a collar using the two strike prices is the way that the examiner has done it.
I do suggest that you read my article on collars, which explains exactly how collars work.
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