Effective Interest Rate

Can someone explain to me why we use LIBOR + Xbps when calculating the FV of the option premiums as opposed to just LIBOR? I viewed the +Xbps as the way the bank earns a profit on the loan (able to borrow at LIBOR and lend at LIBOR + Xbps). I don’t get why we wouldn’t just discount at LIBOR, as this would appear to be the actual borrowing rate for the bank. Is it just because we treat the FV of premium like part of the loan and therefore have to discount it at the same rate as the loan?


It is an opportunity cost - if they buy the option they can’t loan that money out.

Great, thanks.