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Suppose you wish to invest (lend) 50 million for 90 days at a floating rate of 90 day LIBOR +1% pa in 30 days' time.

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Suppose you wish to invest (lend) 50 million for 90 days at a floating rate of 90 day LIBOR +1% pa in 30 days' time. One potential risk is that the LIBOR may fall in 30 days' time. In order to protect your position, you decide to buy an option with an exercise rate of 3% pa expiring after 30 days (i.c. on settlement date). The current premium for the option is 50,000 and the current 30 day LIBOR is 2% pa. What is the premium you need to pay on day 30 from now? Assuming the 90 day LIBOR may take the values of 1, 2, 3, 4 and 5% on the settlement date, show the hedging payoff table including figures on payoff from option, interest received on lending (without option), net interest received with option, total amount (principal + interest) at the end of 90 days (with option), effective lending rate with option and without option. Finally, draw with payoff graph of effective lending rates against all the above possible LIBOR rates with and without the option. (TOTAL 33 MARKS) Suppose you wish to invest (lend) 50 million for 90 days at a floating rate of 90 day LIBOR +1% pa in 30 days' time. One potential risk is that the LIBOR may fall in 30 days' time. In order to protect your position, you decide to buy an option with an exercise rate of 3% pa expiring after 30 days (i.c. on settlement date). The current premium for the option is 50,000 and the current 30 day LIBOR is 2% pa. What is the premium you need to pay on day 30 from now? Assuming the 90 day LIBOR may take the values of 1, 2, 3, 4 and 5% on the settlement date, show the hedging payoff table including figures on payoff from option, interest received on lending (without option), net interest received with option, total amount (principal + interest) at the end of 90 days (with option), effective lending rate with option and without option. Finally, draw with payoff graph of effective lending rates against all the above possible LIBOR rates with and without the option. (TOTAL 33 MARKS)

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