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Hello sir,
Its Troder question in Bpp kit on Interest Rates Risk. I have watched both your lectures on this topic I know the basics but I can’t get my head around this question stuck in this for 5 hours and this is only the second question in kit on this syllabus area and theres still 12 left !In solution they have formed different combinations of put and call strike prices i can’t figure out how ? and why the strike prices are in 00000’s how the author have calculated the interest rates and the premiums for these combinations. Please suggest. Thank you
The question Troder is about creating an interest rate collar using options.
Assuming that you are happy with what is in the two lectures on interest rate options, then you should also read the article that I have written about creating interest rate collars.
You can find it here:
https://opentuition.com/articles/p4/interest-rate-collars/I think that if you read the article it will answer your questions, but if not then do ask again.
Hello sir,
Thanks for your response. I fully understand the theory behind I think I jus need to consoludate my knowledge on this topic and I believe it will come by doing more and more question practice over and over again. Thanks for your lectures and the article. But to be honest I can’t pick the point how the differenr combinations of calls and puts were created in BPP solution!Because Troder is depositing money, they will want to fix a minimum interest rate and they will therefore buy a call option (and there are three exercise prices available in the question – 95.25, which would fix the minimum interest at 4.75%; 95.50 which would fix the minimum interest at 4.5%; and 95.75 which would fix the minimum interest rate at 4.25%.
As you would expect, the higher they fix the minimum rate, the more expensive the option is (the premium).In order to reduce the net premium, they will sell a put option and this will limit the maximum interest rate (at the same rates as above, depending on the exercise price).
Since the maximum interest rate will have to be more than the minimum interest rate (which then creates the collar, if that were not the case then it would all be meaningless), the only three possibilities where this will happen are the three cases that are listed in the answer.
hi sir
regarding this topic, ive read your article,course notes and also have seen your lectures on interest rates.
anyways i just want you to correct me if im wrong, in the concepts that i have acquired . below are the points.
1) call /put strike price:- these were the combination of prices that would give us the minimum interest rates( if we are depositing) and the (maximum interest rates if we are borrowing )
so for call strike price the max is 95750
for put strike price the min is 95250so we will find three possible out comes from the three strike prices given.
2)interest rate:- now , im not 100% sure on this one.
but the reason we are using the call strike price interest rate ( i mean to say (100-95.75) and (100-95.50)so we are using the call strike price )
is because that is because thats the maximum we would ever agree upon.and the put strike price was not, because minimum interest could be anything under 4.25% and 4.5% and we would consider .
im not sure f you get what im saying but thats sort of the logic i came up with in simple terms.
3)the 0.25% thats was deducted was the LIBOR minus 25 basis point.
but i dont understand why this is deducted though? so this is one of my questions.4)the premiums are obviously undertandable , they are from their respective strike prices.
and netting all of this will give us the net receipt.
apologies for making this lengthy .
thanks for your time sir.
regardsHello john, ‘selling a put option’ and ‘buying a put option, what is the difference between these two terms in a very concise style. Thanks
I cannot explain it all simply by typing here.
You need to watch the my free lectures to make sure you understand how options work, and then read my free article on collars which does explain them concisely.
You can find the article here:
https://opentuition.com/articles/p4/interest-rate-collars/I knw it was a stupid question to ask at this level especially after having been watched all lectures and notes. I was doing my 2nd round of ravion and I was stuck again between options ad futures i find this area of syllabus extremely tricky. I have now started to rote learn the techniques the reason behind is that if I learn one thing and proceed to the next one the next thing comes up exactly opposite to the first one from a completely different world. I think the best way is to rote learn this area of syllabus and practice a lot of questions. Any suggestions pls
You cannot pass P4 simply by rote learning – you must make sure that you understand what is happening.
No of course not i know that its just with that one syllabus area i was telling you about we end up learning some of the things anyway
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