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Good day,
In part (a) of this question why did they divide the Investing rate and the Borrowing rate by 4 when calculating the Money Market Hedge?
Regards,
GaryBecause they are hedging transactions that will take place in 3 months time, and there are 4 lots of three months in a year (and the interest rates are always annual interest rates).
I do suggest that you watch the free lecture on money market hedging.
Sir – with regards to this same question. In part (a) when calculating the currency option why did they use put options instead of call? I know they said to protect against a depreciating pound. But what does this mean? How do i know when to use a put option instead of a call option?
Kind regards,
GaryAlso, why when calculating the premium for the exercise price of 1.60 they used the 3month expiry for the exercise price of 1.62? Really confusing to me
First question:
The transaction involves paying $’s, which means we will have to buy $’s and therefore sell GBP’s. We therefore need a put option, giving the right to sell GBP’s. You need to watch the free lectures on foreign exchange risk for a full explanation. (It has nothing to do with whether the $ is appreciating or depreciation).
Second question:
I am not sure I understand what you mean. You use the exercise price to calculate the number of contracts. You use the premium table to calculate the premium in $’s. You then convert the premium to GBP at the current spot rate because the premium is payable immediately.
I hope that you have a wonderful day (and weekend) as well 🙂
Thank you.
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Good day. I have the same question as Jason had. In case of using the put option which has an exercise price of 1.60, when calculating the premium 3-months premium rate of the 1.62 exercise price is used which is 3.42 and not the one provided for the 1.60 which is 2.08. could you please help with the issue.
But in the question, the premium for an exercise price of 1.62 is given as 3.42.
2.08 only applies when going for the exercise price of 1.60.
Good Day
when calculating the number of contracts when the exercise price is $1.62, they consider 23.7 contracts as 23 and not 24? why is this the case? Is it because they would be hedging more than what is required if they consider 24?
There is no special reason and it does not matter whether you round up or down.
The final answer will obviously be slightly different, but in P4 it is not the final answer that gets marks – it is the workings, and you would get full marks either way.
Hello John,
In part (a), when using exercise price of 1.62, should it not be that premium of 30,846 is deducted while calculating total payments to be made? As per examinations answer, the above figure is added while calculating total payments.
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