Question 243 BPP revision kit

Mike does not teach F9 for me, and never has! 🙂

I cannot answer you at the moment because I am away from home at the PQ Awards and do not have the Revision Kit with me.

I get home late tomorrow so please ask again then and I will answer you on Thursday.

I can help answer this I believe.

Firstly, what is an option?

An option is where you pay for the RIGHT (i. “have the option to”… hence it’s name) to exercise a trade at a pre-set price.

A PUT option is an option to sell. A CALL option is the option to buy.

So a PUT option on £500 is the right to sell £500 into say $ at a pre-set price. So sell £, buy $. If the price is in your favour compared to the spot rate, you exercise the trade. If it isn’t, you let the option expire and use the spot rate.

A CALL option on £500 is the right to buy £500 using say $ at a pre-set price. So sell $, buy £. Same as above, exercise the right if it is in your favour compared to the spot.

So this company in based in Farland (let’s call the currency ‘Splot’) is expecting to receive $1,000,000.in 3 months, what option do they require to hedge?

Well if you are receiving $1,000,000 you will have $ in your possession. How do you convert that into the currency you want, ‘Splot’.

The first option is to SELL dollars (put option). In this case we are selling the $1m we will receive to get ‘Splot’.

The second option is to BUY ‘Splot’ (call option). In this case we are buying ‘Splot’, using the $1m we will receive.

Twistedheat: Please do not answer in this forum – it is Ask the Tutor (but please do help people in the other P4 forum).

Furqan understands what options are – they are all explained in full in my free lectures.
He is asking about a specific exam question to do with creating collars.
As I wrote before I will answer him tomorrow.