This was a 25-mark optional question which asked candidates to recommend a hedging strategy for borrowing using interest rate futures, options and option collars in part (a).

And in part (b), the question moved on to examine how the derivatives markets operate and tested whether the candidates understood the difference between the time value and the intrinsic value of an option.

Part (a) was done reasonably well by most of the candidates who chose it as one of their two questions. Many candidates were able to identify that the correct futures hedge was to go short and to purchase put options, and how a collar should be constructed.

Many candidates were also able calculate the number of contracts and the remaining basis. The calculations involving futures and options were done a little bit better than the collar calculations.

Common errors included: not calculating the number of contracts and/or remaining basis correctly because of confusion with the months, not giving the amount reduction although the CEO requested this and constructing the collar to sell the put and buy the call.

The discussion element was done well and most candidates got 2 to 3 marks for it.