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I am having a great deal of problems understanding how the examiner was able to deduce the “call strike price” and the “put strike price” in this question. I pretty much figured out how to work out the other components of the calculation, and I’m really not understanding the collar problem. Looking forward to some help in this question.
P.S. Asked this question before, but still havent been able to work it out since.
I am not sure which question you mean, because question 46 of the current BPP kit does not have collars in it.
However, you can choose any strike price you like in order to explain the possibilities – there is no ‘correct’ strike price. The strike price is your choice in real life – the premium payable depends on which one you choose.
If you are borrowing money, then by buying a put option you are effectively fixing the maximum interest rate that you will have to pay.
So (for example) choosing a strike of 95 will fix the maximum interest you will have to pay at 5% (ignoring the premium). On the other hand, if you choose a strike of 94 it will fix a maximum interest rate of 6%. You can choose whichever you want – the premium will be higher the lower the maximum you fix.On the other hand, selling a call option will fix a minimum interest rate. If you are borrowing money, you would obviously not usually want to fix a minimum – only a maximum. However the reason you might be prepared to do it is that you will receive a premium. Since it will cost you money to fix a maximum, it means that if you sell a call then you will still keep the maximum rate but the net cost will be lower.
Have you watched the lectures on this (free on the website)?
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Thanks very much , i was also confused about that matter , but now it is clear understood
The Troder question is now question number 51 in BPP kit.
I do not understand why, in the answer, they deduct 0.25% in calculating net receipt?
The only thing I can see in the question is that the company can invest short term at LIBOR minus 25 basis points. I have no idea why this should be included in calculating collar’s net receipt?
As always, thank you for your help!The company is investing, and the collar limits the minimum and maximum LIBOR rates (the price of the futures moves with LIBOR).
Since they will be investing at LIBOR – 0.25%, the limits actually applying to them will also be 0.25% less than those given by the options.
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