Interest Rate Options – Awan Dec 13

Hi John,

I’m just working through this question on Interest Rate Options. I understand how to do the options and I understand the examiner’s answer. My question is more about technique.

The examiners answer for the option that is not exercised:

Investment return (4.79% x 4/12 x $48m) $766,400
Gain on options Zero
Premium 0.0021 x $2m x 3/12 x 32 ($19,360)
Net Return $747,040
Interest Rate 4.67%

So in effect, they take the annual interest rates, work it out in for part of the year and then annualise it up again.

My answer was a lot more simple (and quicker!!) and just kept the interest rates annualised, as follows:

Interest Paid 4.79%
Premium (0.121%)
Rate 4.67%

If I need to, I can still work out the interest paid by calculating $48m x 0.0467/3 = £747,200, but this particular question didn’t ask for that.

Doing it this way helps me enormously to get a question like this done in the time, but would I get the full marks for it?!

This is the first time I’ve asked you a question, but just wanted to let you know that you’ve been a fantastic help with all the many many questions you’ve answered in the past that I’ve been able to search, so thanks so much for that. You make the chore of a self studier much much easier 🙂

Roz