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Hello – I’ve been struggling in one area and hopefully you might be able to help.
In the question Phobos a) ii) using the option on short sterling futures I cannot figure out the rationale for choosing the exercise price of 94000.
Apologies if I’m missing something obvious.
Thanks
Daniel
Probably cause of the fact that the trasurer wishes to fix the max rate at 6.6%
94000=6%
phobos premium=0.5%
put premium=.168%
that would give a total of 6.668%
the other two options give you an max interest rate of 6.795% & 6.55%,but in the latter case the premium is high and it would be a waste if the interest rate happens to fall,so we stick the cap at 94000.arjundilip: Please do not answer questions in this forum – it is Ask the Tutor, and you are not the tutor (but please do help people in the other P4 forum) 🙂
danhealy18: arjundilip is correct in what he has written.
Hi Sir, if in this question (option part), we calculate all the possible outcome (3 possible exercise price) and EIR and we didn’t comment which exercise price we choose , (but definitely is march put option).
can we still get the full mark? because i feel the exercise price 94250 is also suitable for company since the EIR also below 6.6% no matter the LIBOR is +1 % or -1%
You can use any exercise price because the marks are to prove that you know how options work.
Hello John,
In part a (i), why do we choose March futures contract at 93.88 instead of September futures contract of 93.97 ?
I guess we have to look the month nearer to which we are borrowing rather than the month to which we are making repayment. Right? (Repayment being made on 01 July, hence my logic to use September futures contract).
However, if we were hedging currency using futures, then we would have chosen the futures contract which is nearer to payment / receipt date? In this question we are hedging Interest rates, right?
The borrowing will start on 1 March and w always choose the futures that mature first after the start of the borrowing – which is March futures. (The interest rate is fixed at the start of the borrowing and it is changes in the interest rate between now and the start of the borrowing that we are hedging against).
With foreign exchange futures we choose the future ending first after the date of the transaction.I do suggest that you watch my free lectures on interest rate risk management.
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