Question 3 - Part a

In this lesson

1. 0:00 Introduction to hedging calculations and setup
2. 4:14 Basis working and futures price calculations
3. 10:02 Option pricing and exercise decision
4. 14:55 Premium calculation and effective interest rate
5. 18:10 Swap structure and comparative advantage analysis
6. 22:30 Swap mechanics with bank charges
7. 28:20 Comparing hedging instruments and risk analysis

About this lesson

You'll learn how to set up and execute option and swap calculations, including identifying whether to use a call or put option, calculating the number of contracts needed, performing basis workings, and determining the effective borrowing rate when using options as a hedge. The lesson covers the complete mechanics of hedging with interest rate options. You'll see how to structure your spreadsheet for clarity, convert annual rates to the time periods you're borrowing for, work out opening and closing futures prices using basis calculations, and then calculate the option outcome by comparing the exercise price to the closing futures price. A critical step is determining your net interest payment by combining the market borrowing rate, the option profit or loss, and the premium cost—then converting this to an effective annual rate for easy comparison with other hedging methods. This is essential preparation for Advanced Financial Management (AFM) and Strategic Business Leader (SBL) case study questions where you'll need to compare multiple hedging instruments. The structured approach shown here—setting up clearly, showing all working, and calculating effective rates—will help you score marks for methodology even if calculations become time-pressured. You'll also see how to present your findings in a way that demonstrates you understand not just the numbers, but when and why each hedging tool is appropriate.

Duration: 32m