On Schweser pages 182-187, there are some examples showing us the calculations on interest rate calls vs puts.
First, on interest rate calls, they use an example where the loan is $5 million and there is an interest rate call option for $8k premium. They adjust this premium for the options maturity (i.e. calculate its FV) and say that the net amount to be borrowed after the option would be ~$4,99 million. So, in my understanding, the borrower would receive the $5 million loan but would have paid the $8k option adjusted for FV.
Then, on interest rate puts they say that the lender provides the borrower with $5 million + the FV of the put premium. So, it’d be around ~$5.01 million.
SO, which amount is actually being borrowed/lent? I’m confused.
They should state in each question whether is subject borrower or lender. Put option protects lender, call option protects borrower. Sometimes, subject, lender (or borrower in same cases) may construct a collar which purpose is offset the cost of premium partially or in full. Collar might not be exactly zero cost if shorted option expires ITM in case the subject would have cash outflow.
I checked. Each sentence in each sample starts with something like this “The firm wants to borrow” or “The Bank will lend”. The collar should be in the last example.
But my question is about the loan amount. In one example they say its less than 5 million, while in the other by adding the cost of the put it becomes more than 5 million. It makes no sense to me.
Just to add to what Flashback mentioned, as interest rate calls benefit the borrower and interest rate puts benefit the lender, so in the first case, borrower has to make a premium payment to get the benefit of the interest rate calls and hence his net borrowing amount is reduced by option’s adjusted premium value, whereas in the second case, the lender has to make a premium payment to get the benefit of interest rate put and hence his net outflow is increased by option’s adjusted premium value.