I don’t understand calculation for option premium
If you mean the one in the schweser book, check the errata on their website.
Reading 46 CFAI books end of chapter
I did, but I don’t have the book in front of me now. I’ll try to answer in an hour or two.
It took me longer than expected but here’s how I see it: You will be buying calls -> i.e. right to buy pounds. Let’s take second call with the strike price of 1.55$/pound, and call premium (in $/pound) of 0.015 Amount you need to hedge = 15mm/1.55 (i.e. at call's strike price) = 9,677,419 pounds Calls premium = 0.015/pound x 10mm pounds = 145,161$ And lastly, convert calls premium back to pounds (b/c you will need to subtract it from your portfolio value in pounds. To convert use current spot exchange rate, since you’re buying calls today) = $145,161/1.5 = 96,774 pounds And to confirm: if spot rate is 1.6, you will exercise the call Portfolio Value = $15mm/1.55-call premium = 9,580,645 pounds In Solutions the answer is 9,577K pounds. I assume the difference is due to rounding, but I’m not 100% sure.
this is where i get confused the table in the question has strike and call pound. I thought call pound is the premium of call in pounds and not in $/pound. So currency options premium prices are quoted in currency/per currency? Amount you need to hedge = $15mm/1.55 (i.e. at call’s strike price) = 9,677,419 pounds Shouldn’t the amount you need to hedge be calculated using initial spot price and not the strike price? In CFA answer table for all cases they have amount hedged: 10,000,000 pounds
I should have used “insured” instead of “hedged”. The “hedged” column in CFA answer table refers to hedging with forward contracts. In that case you will get 10mm pounds no matter what future spot exchange rate will be. At the top of the table on p185 it says "March Sterling Options (all prices in per pound)", so that's why I assumed that call premium is given in /pound (although it’s kind of weird for premium to be in /pound instead of just or pounds). I still think that amount to be insured needs to be calculated at strike price, and not initial spot price (else you might end up buying more options than need to).
Where you given pounds or dollars?
Table on p185 (CFAI Reading, V6) - at the top it says “March Sterling Options (all prices in $ per pound)” and then two columns of that table are labeled - Strike & Call Pound
tanyusha, Were you able to figure out this problem? I don’t understand why they used the strike price, 1.5 $/pound, to convert the option premium to pounds, instead of the spot price. I think this is the same question you had.
Here is my thought: I’ll take the same example, 1) The amount you want to hedge = 15M = P 10M (P = pound), so premium = (/P 0.015)(P 10M) = $ 0.15M = P 0.1 M 2) if the spot rate is 1.3, you’ll pass the call, $15M@1.3 = P 11.538M. Subtract premium = P 11.438M 3) if the spot rate is 1.6, you’ll exercise the call at stike, $15M@1.55 = P 9.677M. Subtract premium = P 9.577M This yields exact numbers in the answer sheet. Hope it helps