Hello guys,
In this question, the answer shows the loan interest calculation to use 6%. Shouldn’t it be 5% (the rate 6 monhs before) or am I missing something?
thanks
looks right to me
only use current when calculating the premium
but here we are calculating the interest on reset date
anyone ?
has anybody tried this question?
they are asking you to calculate it at the reset … in the question. so just follow the instructions.
there are 2 calculations requried for the first reset date which is 6 months from now:
1.time value of your cost of collar:
use current libor rate: 5%+2% spread
- expriation interest rate:
because libor is between 4.5% to 6%, and rate at expiration is 6%,
we are indifferent b/t call and market libor at expiration.
we use 6%+2%
which one are you confused about?
as mentioned above, the 2nd one -loan interest.
For a semiannual reset floating rate instrument, the interest on reset is calculated based on LIBOR 6m back. So for this question, the loan interest on June 30th, should be calculated based on 180-day LIBOR of Jan 1st ?
they tell you to use the reset date rate in the question. so even if that is the usual way - here it is different.
if T is the interest receving date, T-6m is the LIBOR reset date and it is 6% on that day, make sense?
they asked you the interest received 6 month later.
Dec 31st, given a 180-day spot LIBOR of 6.0% on the June 30th reset date. The interest would be received 6 month later after the reset date.
Since its a collar, I am assuming that we are buying Put and selling Call. Why are we subtracting Call premium instead of adding?
($130,000 - $100,000)[1 + (.05 + .02)(180/360)]
Interest is paid in arreas. As mentioned above, interest today will be used to calculate payment in 6 months. T6 Interest will be used to calculate payment at T12, and so on.
@snua7 we are buying a put for $130k and receive $100k for selling a call. Thus, you are paying out cash of $30k (lending it) and adding the interest until you receive payback at 180days. Therefore it gets added to the principal amount.
Got it, thank you
There is one thing in this question I don’t understand.
Why they add 31050 (FV of collar premium) to the loan?
I think they should substract it, not add.
If I borrowed X and also paid Y, I effectively borrowed X-Y. I have less money on hand, not more.
And my interest rate grows, not drops. It looks a bit absurd as if I spend more money (for example destroy half of the money by dropping it into trash), my rate goes down?
Its correct, for banks making a loan, the cost of the option is added to the denominator therefore lowering the interest rate in the numerator, in exchange for a hedge they make less. For the borrower, the cost would be subtracted from the denominator making it more expensive to hedge, a higher interest rate. Interest rates are revenue to banks and cost to borrowers. If banks made more by hedging and borrowers spent less by hedging, every loan would be hedged.
Oh yes, thank you. The question is from bank’s perspective and my mistake was that I was assuming borrower’s perspective.
Sure, I get about 3 wrong per test by misreading which I hope to cut down to zero by test time.