Straddle

I am surprised that they mentioned a straddle in the mock exam (and I will be very surprised if it is mentioned in the real exam). You will know what an interest rate collar is, it is where you fix both a minimum and a maximum interest rate. If you buy a put and sell a call at the same exercise price then you can use it to effectively fix the interest rate. In a sense, a straddle is the opposite - you would buy a put option and buy a call option at the same strike price (whether they be options on interest rate futures, or exchange rates, or share prices). The reason that they are really less relevant for the financial manager (and therefore for the P4 exam) is that it is not done to reduce risk. Rather it is done to make potentially a big profit if the actual interest rate/exchange rate/share price changes a lot. It is however a very risky way of proceeding.

Dear Tutor, In the exam, if we have 3 strike prices say, 90, 92 and 94. And I have chosen say 90 as my Put strike because i am borrowing, to compute for Collars, do i have to use each of the 3 strike prices individually and compare or i just select one? From the exam paper in June 11, there were 2 strike prices, One was already chosen as the Put and the other was selected to calculate the collar. Please advice Thanks

It really depends on the question. If you are just asked to illustrate, then just one put and one call is sufficient. Otherwise, ideally, you would look at all combinations.

Thanks for all your support

You are very welcome :-)