cfasf1 Wrote: ------------------------------------------------------- > Bankin’ Wrote: > -------------------------------------------------- > ----- > > Proposed answer: > > > > Net loan amount > > = 5MM – 8M(1 + (0.08 * 40/360)) > > = 4,991,929 > > > > Call Payoff > > = 5MM(0.05 - 0.045) (180/360) = $12,500 > > > > Dollar Cost of Loan > > =5MM * 0.08 * (180/360) – 12,500 = $187,500 > > > > Effective Annual Rate > > = ($5,187,500 / $4,991,929)^(365/180) -1 > > = 0.081043 or 8.1% > > > > > > When I did this problem I calculated it the > same > > way that Corrupted did. Can someone explain > why > > the interest as 0.08 * 180/360 as opposed to > > 1.08^180/360? > > I think you were asking why just multiply instead > of ^180/360, correct? does anyone know? i’m not > sure. > That is what I was asking. > also. when calculating the fv of the call option, > i just used current libor… i see you guys used > the terms of the loan. (adding 300bps) which is > correct? I always thought, at least through > schweser, we just use current libor because the > loan terms are separate from the call option… You use the rate on the loan rather than Libor flat, because that is (theoretically) what you could earn on the money rather than putting had you lent it out rather than purchasing the option.
could have sworn the example in schweser used libor by itself. but it wouldn’t be the first time schweser was wrong. don’t have my books, so can’t check…
cfasf1, just checked Schweser and they do it the way CFAI says.
thanks. so the loan rate to get the future value of the premium? will keep that in mind.
Yup, and I’ll go with bankin’s explanation on that.
SF, think about it this way. Since, in the effective rate calculation, you are saying that you didn’t get to borrow 5M at LIBOR+3% but some lesser amount due to the cost of the premium the rate needs to agree with both. So the denominator is 5M (LIBOR+3) - option premium (@FV LIBOR+3). The effective loan amount is the difference of the two and the “terms must agree”. Edit: although I usually agree with bankin, I am not sure on this one. I don’t know if you can assume that is the rate they will earn on the “lost” premium. That is the firm cost of funds, not their expected return.
using that rate makes more sense anyway you cut it. i don’t know why i thought we just used libor. i swear i read it somewhere… but obviously didn’t.
thanks guys. i actually hope this ends up on the test.
mwvt9 Wrote: ------------------------------------------------------- > Edit: although I usually agree with bankin, I am > not sure on this one. I don’t know if you can > assume that is the rate they will earn on the > “lost” premium. That is the firm cost of funds, > not their expected return. I think we are saying the same thing, we’re just looking at it from a slightly different angle. I’m saying that at the time you purchase the option you pay cash for it. Theoretically, had you not purchased the option, that cash could have been lent at, in this case, Libor + 300 since that is the ‘market’ interest rate. So you have to reduce your loan amount in what ultimately becomes the denominator of the final calculation, by the call premium plus the lost interest that you could have earned on the $8,000 between the time your purchased the premium and the time that you originated the loan. Does that make sense?