Interest rate collar exercise, interest, LIBOR, current, following

Dapper425

The current LIBOR rate is 4%. Which of the following interest rate collar will have the lowest cost?

A) buy interest rate put at exercise rate of 3.0%, sell interest rate call at exercise rate of 4.5%

B) buy interest rate put at exercise rate of 3.0%, sell interest rate call at exercise rate of 5.0%

C) buy interest rate put at exercise rate of 4.0%, sell interest rate call at exercise rate of 5.5%

liangfeng

One of the best questions I have seen here in a while.

Thanks OP

bodhisattva

hooray for cfasniper

bpdulog

Good analysis , I got fooled too , and selected B . Should have read the q slowly.

Colum

Since you are short the call, its more valuable to the purchaser so it you gain more from the initial sale.

Since you are buying a put with a lower strike, it will cost less.


Thus its the lowest cost collar in terms of setting it up initially.

mar350

pimpineasy Wrote:
-------------------------------------------------------
> CFASniper Wrote:
> --------------------------------------------------
> -----
> > I think this question is best solved by
> > elimination
> >
> > First off, you can rule out C because buying
> ATM
> > put (this is where knowing current LIBOR helps)
> is
> > going to be more expensive than buying a put at
> 3%
> > strike (OTM).
> >
> > So, the puts in A & B will cost you the same
> > amount as both have 3% strike.
> >
> > On the short call side, you will make more
> premium
> > by selling a call that is deeper in the money.
> > i.e. selling a call at strike 5% will fetch you
> > more than a call at 4.5% (given current LIBOR
> is
> > 4%)
> >
> > Therefore, my answer is
> >
> > B
>
>
>
> sniper hold on soldier which is more valuable to
> you a call @ 4.5% or a call @ 5%?
>
> i would think a call @ 4.5 no


But you are SHORT that call, Seargent!!!

bboo

exactly so u make more money from it so hence the collar will have a LOWER cost



Edited 1 time(s). Last edit at Saturday, May 14, 2011 at 01:39PM by pimpineasy.

strikethree

agree with you...Call@4.5 is more valuable than call@5.0% and will bring more premium. answer shud be B...

ohai

CFASniper Wrote:
-------------------------------------------------------
> I think this question is best solved by
> elimination
>
> First off, you can rule out C because buying ATM
> put (this is where knowing current LIBOR helps) is
> going to be more expensive than buying a put at 3%
> strike (OTM).
>
> So, the puts in A & B will cost you the same
> amount as both have 3% strike.
>
> On the short call side, you will make more premium
> by selling a call that is deeper in the money.
> i.e. selling a call at strike 5% will fetch you
> more than a call at 4.5% (given current LIBOR is
> 4%)
>
> Therefore, my answer is
>
> B



sniper hold on soldier which is more valuable to you a call @ 4.5% or a call @ 5%?

i would think a call @ 4.5 no

NakedPuts00

Originally posted as "B", the answer is "A".

I have three weeks to figure out how to read questions more carefully.



Edited 1 time(s). Last edit at Saturday, May 14, 2011 at 10:53AM by BTON04.