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With regard to this question,
I want to ask why we are considering the futures price when the question clearly states
“Therefore she is considering options on interest rate futures or interest rate collars as possible methods of hedging, but not interest rate futures.”I’ve cracked my head on it and the the reason I can think of is that its because we are using the current futures price to predict the future *spot* price. Is that correct?
Just giving the links below for your easy reference. Its Qn 2
Question
https://www.accaglobal.com/content/dam/ACCA_Global/Students/prof/p4/Exam%20docs/d15_hybrid_p4_q.pdf
Answer
https://www.accaglobal.com/content/dam/acca/global/PDFstudents/acca/p4/exampapers/P4_2015_dec-a.pdfNow that I’m thinking on it again,
My answer cant be correct. Because the predicted spot rate is already given at 4.1 and 3.1%
The suggested solution looks to consider the futures like an alternative to taking the options but as quoted above, the manager does not want to consider futures.
So why are we considering options?
Interest rate options are options to buy or sell interest rate futures. She is not using futures to hedge the interest rate risk – she is using options on futures.
To decide whether or not the options will be exercised in each of the two scenarios you need to calculate what will happen to the futures price as the interest rate changes, taking account of the basis risk.You cannot possibly learn how to deal with the managing of interest rate risk by simply looking at past questions – the calculations involved are far too technical. You need to study it first, and again you must watch my free lectures on all of this.
Please ignore the above
Regards to the question,
So we are trying to see whether or not the option would be worth it or not. If it is worth it then we taken it. If its not, then we’re not taking the normal future either because thats what the examiner specified. Right?The examiner specifying he didn’t want futures was just to tell us that we shouldnt use futures as part of the hedging strategy that we suggest and that phrase has no effect on this particular question on options right?
About the collars, (I went and watched your lecture on it)
I wanna know why the examiner has taken the buy call at 97 and not at 96.50.
Like if we have the call at 96.5, that gives us a better interest of 3.5% since we are investing this money.
So why did the examiner use 3% rather than 3.5%.I have studied the course. I used Acccowtancy for it though.
And I will be watching your lectures a little too because they did help me top in the country for F5 but since the exam is a week away, I need to balance it very carefully with question practice obviously.
Dealing in futures and using options on futures are two different ways of hedging interest rate risk. The question says they are not going to deal in futures but are considering using options. Since options are options on futures, it is still necessary to know how futures work and how the futures price will change.
Buying a call option at 97.00 limits the minimum interest rate to 3% (since they are investing money). Selling a put option at 96.50 limits the maximum interest rate to 3.5%.
(Although obviously the actual effective interest rate also depend on the premiums and the change in the basis).Given that you studied this elsewhere, I am surprised that you are not asking them to explain! I am more than happy to explain anything that is not clear in my lectures, but I am not going to type them out here – we do not give private tuition 🙂
Just watching a lecture on collars is not enough – it makes no sense unless you fully understand how options in interest rate futures work (which means understanding how futures work as well).
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