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hello sir I am self study student and am having alot of difficulty in this topic.I was badly stressed out last night because it has been 4 days and I can not find a format for solving this type of questions.
1) why in some questions in the bpp kit they are solving as % by substracting from 100 like in Alecto but not in other questions?
2) where do we look for closing future price ? will it be given or if theres a future hedging asked we have to derive from there?
3)why are there ticks given in some question and how do we calcualte using them
4) lastly and more importantly pls tell me a brief rule on when do we exercise an option if borrowing loan ?? like if the exercise price is higher or closing?I have watched your lecture on options but am finding these questions way too difficult if you a video of solving an option question pls mention
thanks alot
You say you have watched the lectures on options, but have you watched all the lectures on interest rate risk management? It would seem not, and you must because interest rate options are options to buy or sell futures and you cannot learn options without understanding futures. Also, you cannot expect me to type out all my lectures here 🙂
Futures prices are always 100 – the equivalent interest rate. So, for example, interest of 10% would have an equivalent futures price of 90. I explain this in the lectures with examples.
You will never be given the closing futures price. You will either be given the interest rate at the date of the transaction (and can then calculate the futures price using the fact that the basis risk falls linearly to zero over the life of the future) or, if the interest rate is not given then you use the lock-in rate. Again, both of those are explained in my lectures.
A tick is the smallest movement in a future, which for exchange rate futures is 0.0001 and for interest rate futures is 0.01. Again, I explain ticks in my free lectures (although you never need to use ticks in the exam – I never bother using ticks, but that is up to you 🙂 )
As far as exercising options is concerned, if you are borrowing money then you will have bought a put option. This is the right to sell futures at a fixed price and you will therefore exercise it if the futures price ends up less than the exercise price (which will happen if the interest rate is higher than the equivalent interest rate for the exercise price).
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