Reading 35 question 7, calculation of option premium

CFA Level III
#1

Hi folks,

I am stuck with question seven in Reading 35, especially the calculation of the option premium gives me a hard time.

In the solution they calculate for the March 1.5 calls:

15,000,000/1,5 * 0,03=300,000 Dollar resulting in 300,000/1,5=200,000 pounds unsing the current spot rate.

I don’t understand the expression 15,000,000/1.5. Is the 1.5 the strike price? If yes, in the next calculation they should have used 1.55 and 1.6 strikes, but they haven’t.

Did anyone have the same question and already the answer?

Thanks for any answer and good luck to all!

#2

1.5 is the spot exchange rate $/GBP.

#3

Hm, but why do I apply the spot rate of 1.5 $/GBP two times in the formula?

#4

“I don’t understand the expression 15,000,000/1.5. Is the 1.5 the strike price? If yes, in the next calculation they should have used 1.55 and 1.6 strikes, but they haven’t.”

Something is funny.

All of the calculation that they show, is only for $1.5/GBP call. They don’t show the calculations for the 1.55 and 1.6 calls.

Profit on call = $15M/1.7 - $15M/1.55.

Decline in your portfolio value = $15M/1.5 (in Nov) - $15M/1.7 (in March). Unlike the 1.5 case, the decline is MORE than the profit on call (which is why the 1.55 call was cheaper.) Think of your $15M as a variable asset in GBP terms, when GBP goes up your asset falls in value.

Your net loss = (option premium = 0.015 GBP * 15M/1.5(/GBP) when you bought it = 0.015 * 10M GBP) + Decline in your portfolio value - Profit on call =

150K + 1176K - 854K = 472K GBP. I am not sure how they got 9577K, I am getting 10M-472K = 9528K.

EDIT:

My bad, the call prices are in , not GBP. Which is strange because you are based in Britain. But anyway, the option premium is not 0.015 GBP but 0.015 or 0.010 GBP, which means a total premium of 100K GBP which means a total loss of 422K or a value of 9578K, close to the book’s value.

#5

Why are you reading the books when your status is Passed level III

#6

Dollars->Pounds->Call premium in dollars->call premium in pounds .

Each time you go from Dollars to Pounds , you divide by spot . You go from dollars to pounds twice , once for principal and one for premium . so two divisions by spot rate

#7

Hi folks,

I was a few days off. Thanks for your comments, I got it.

The call prices are in dollar and so is the amount we receive. To get the total option premium we have to

  1. calculate the calls we need. We have to convert the 15,000,000 $ into pounds. Because we can by the exact amount off calls, the contract value is 1.

So: 15,000,000$ divided by the current spot rate 1.5 gives us 10,000,000 pounds, the amount we need calls for.

  1. convert the Call price into pount:

0,015 $ divided by the current spot rate 1.5 dollar/pound = 0,01 pounds -> This ist the price of the 1.55 strike call in pounds

Result: 10,000,000 pounds multiplied by 0,01 pounds = 100,000 pounds, the premium to be paid for the 1.55 calls

Btw: I am a level III candidate. I somehow messed up my profile, hope it’s fine now.