Wrong EOC answer! #7 of Reading 40 (Currency Risk Mgt) 150, instead, leading, change

yodacaia

Anyone found that the calculation to the #7 EOCQ of Reading 40 was wrong?
The [insured with call 155] and [insured with call 160] are all using $1.5/pound to calculate the option premium instead the $1.55/pound and $1.6/pound respectively, leading to the last columns of the answer table full of wrong numbers.
The option premium should be found with the formula of {(principle in $/strike price)*(option price in $ / strike price)}, i.e., the premium should change with strike price applied, 150, 155, then 160.
After correction, I’ve got following numbers:
[Exchange Rate, $/pound] [insured with call 155] [insured with call 160]
1.3 11,445 11,509
1.4 10,621 10,685
1.5 9,906 9,971
1.6 9,584 9,346
1.7 9,584 9,346
1.8 9,584 9,346
Anyone can confirm my recalculated results?

Roflnadal

Yes you are right . To protect our current principle , we lock in at the current spot rate ( hoping of course to cash in on a better rate at expiry).
So insured UK # = 15M USD / Spot Rate in USDperUK#
Cost of insurance in USD = insured UK # * option price
Cost of Insurance in UK # = insured UK # * option price / spot rate
giving 9577 thousand as in the CFAI text

Windjam

janakisri, different from your opinion again!
I think the ECO answer is right.
Option premium should be decided only by spot rate, both the principle and option price. After serious thinking, I understand that it does not make sense to calculate the principle by strike price because you have no idea whether you are going to strike it or not when you are just about to pay the premium on the option.
The formula to the option premium should be:
UK # Cost of premium= (Principle in USD/ Spot Rate in USD per UK#) * (option price in USD per UK# / Spot Rate in USD per UK#)

justin88

Thanks very much for the clear explaination, janakisri!

mp3bu

I think I disagree on option premium:
option premium is paid in spot terms at the beginning of the period , i.e. in December for March delivery. The cost is :
UK # Cost of premium=
(Principle in USD/Strike Rate in USD per UK#) * option price in USD per UK# / Spot Rate in USD per UK#
This gives :
UK # Cost of Premium= 15M/1.55 * 0.015/1.5 = UK# 96,774
Conversion of 15M USD @1.55 = UK#9,677,419
Gives a net UK Pounds of 9,580 thousand, much closer to CFAI answer of 9,577 thousand
You are making the mistake that the premium can be converted at the STRIKE RATE , while actually it is paid up front and converted at the SPOT Rate prevailing

Viceroy

i confirm that it should, or could be 1.9380s80isalkjsdklaioe9l.
however, if you factor in the deltoid with that factorization formulaic theory on black scholemanstein, you get a different answer, but you have to run it through the quantum linear optimizer and postmortem for convexitization hydration, which, as an estimate for the point estimator, you get 90828982.909s0kkl.sk
make sensical?