Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Solution to Stage Seventeen

1.	If the bond price goes up to 95, I exercise the option (that is, to buy the bond at 85), sell it on the market for a profit of 10 (95 – 85). Given the premium expense of 6, my net revenue is 4.
2.	If the bond price goes down to 80, I shall not use the option since it is cheaper to buy the bond at its market price. I would then have lost the option premium of 6.
3.	If I believe that interest rates will increase (i.e., the bond price falling), I would sell (write) call options for a premium. If these options are not exercised, my profit would be the option premium received.