For the interest rate call option,
the examples in the Kaplan uses the FV of call option premium and deduct that from Loan amount to get net amount.
Cost of borrowing: FV(preimum)=premium(1+(current LIBOR+spread)(maturity/360))
Does it mean we are borrowing the call option premium? If so, why borrow instead of buying?
Thank you!
No. This means that option premium makes borrowing more expensive. Thus is shown as deductible from received loan.
Put option is used at creditor side but with same outcome, it decreases an interest income and there is added to placed loan amount.
If both mentioned hedging strategies were not utilized and options expire worthless, party who used options spent more or earned less than in scenario of non using options.
That makes sense. Thanks, Flashback! I think today is one of those days…
No problem. We have 3 months to survive.
As per my understanding, we are borrowing the premium money also. That is why we have to multiple the premium amount by the libor+spread to calculate premium amount.