Please show the CFAI page number. The answer doesn’t make sense to me.
i dont get why this is so difficult…u own an a IOU note basically…at time T if the other party goes under how much do u lose? u lose whatever the IOU is worth full stop…
pimpineasy Wrote: ------------------------------------------------------- > i dont get why this is so difficult…u > own an a IOU note basically…at time T if > the other party goes under how much do u lose? > > u lose whatever the IOU is worth full > stop… The premium is a sunk cost. It’s lost regardless the counterparty goes under or not. Just post the page of this CFAI question please.
im not referring to the premium,…u lose whatever the iou is trading foir in the marketplace
revisor Wrote: ------------------------------------------------------- > pfcfaataf Wrote: > -------------------------------------------------- > ----- > > lets say: you bought this option as a hedge; > > your counterparty defaults long before the > expiry > > of the option and you need to replace this > option > > with a new one to reconstitute the hedge. You > will > > have to pay for the new option current value = > > premium. > > > > so the effect of credit risk is additional cost > > equal to premium of the new option. > > CFAI differentiates between potential credit risk > and realized credit risk (I don’t remember the > exact term). In that case, it would be not the > potential credit risk regarding this option; when > talked about potential risk, it is not certain > whether the counterparty will default. the question above asks about potential credit risk, this is the risk I have been talking about, the other credit risk is current credit risk. and about sunk cost from other post, that the cost is sunk does not mean that the option (it is buyers asset) does not have value. The risk that you lose this value due to the counterparty default is the potential credit risk.
So let’s say you go and buy a mattress and pay $500 upfront for delivery. Since you paid for it , it is a sunk cost. Let’s say no refunds allowed etc. Now do you have a credit risk or no? You just paid $500 . That’s what the mattress is worth to you. If you don’t get delivery of said mattress , that’s what you lose . $500. If delivery is after a month and mattresses sell for $505.50 then that’s what you lose if you don’t get delivery in a month. Today its worth is $500 , yes? Same story with the option . Potentially and currently seller owes you $7 for something he has to deliver at expiry ( European ) , and it may be worth $200 then , but it is worth $7 today , yes?
A. it’s an european option. can’t exercise prior to expiration date.
Doesn’t mean its potential value is zero. Its worth exactly what it is pricing today , which is $7. That’s the credit risk to you if the seller goes bust and becomes unlikely to deliver on expiry
Please show where you got this question on CFAI books. Thanks
guys - I think you are not distinguishing between POTENTIAL and CURRENT CREDIT RISK. Potential Credit Risk - is 7$. (European or otherwise). Current Credit Risk is 0. (European, so credit risk does not arise till exercised and so on…).
mik82, check out Page 288 of Volume 5 in answer to Question 17 B.
cpk123 Wrote: ------------------------------------------------------- > guys - I think you are not distinguishing between > POTENTIAL and CURRENT CREDIT RISK. > > Potential Credit Risk - is 7$. (European or > otherwise). > Current Credit Risk is 0. (European, so credit > risk does not arise till exercised and so on…). hmmmmmm a wise distinction
so… Greg buys a Call option. The strike price of this European option is $105 and the option sells for $7. Underlying is now trading for 110. Potential = 12 current = 5 ???
Well in this case there will be no current credit risk because the option is european. There can only be potential credit risk.
Well, as others have pointed out this question is “similar” to the EOC and DIFFERENT from Fy2008 Question 7 (Red River Question). Current VALUE of potential credit risk. If the option is trading at $7, that is the value. Answer is “C”
c… potential credit risk. you are paying $7 for the option, so there is obviously “potential” value there. pretty confusing.
oops. didnt read the whole way down in the post. my answer isnt necessary.
I think me.tega asks a good question, about whether the potential credit risk would be $12 if it sells for $7 and is already $5 above the strike price. I think in that case the answer would still be $7, because that’s the value of the option, which is what you would lose if your counterparty disappeared.