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Derivatives and Alternative Investments - Interest Rate Options

Kursangebot | Derivatives and Alternative Investments | Interest Rate Options

Derivatives and Alternative Investments

Interest Rate Options

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Compare and contrast interest Rate Options with forward rate agreements (FRAs).

Interest Rate Options and FRAs

For interest rate options, the exercise price is an interest rate, and payoffs depend on a reference rate such as LIBOR.

The combination of a long interest rate call option plus a short interest rate put option has the same payoff as an FRA.

Long interest rate call + short interest rate put = FRA

Interest Rate Option

FRA

Payoff is made

After the option expiration

At settlement

Beispiel

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Example:

A long interest rate call and a short interest rate put is an equivalent position to:

A. a long position in a forward rate agreement.

B. a pay-fixed interest rate swap.

C. a short position in a forward rate agreement.  

The answer is A. A long call and short put on interest rates is equivalent to a long position in a forward rate agreement. Both gain when forward rates increase and decline in value when interest rates decrease.

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Define interest rate caps, floors, and collars.

Interest Rate Caps, Floors and Collars

A caplet is a European call option on interest rates. An interest rate cap is a combination of caplets, with each caplet having the same strike rate (cap rate).

A floorlet is a European put option on interest rates. An interest rate floor is a combination of floorlets, with each floorlet having the same strike rate (floor rate).

An interest rate collar is a combination of a long (short) cap and a short (long) floor on the same underlying rate with the same expiring dates.

Floating-rate loan borrowers can long a cap and short a floor to hedge the risk of interest rates.

The value of a cap or a floor is just the sum of the values of the individual caplets or floorlets.

Caps and floors pay in arrears.

Beispiel

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Example:

An investor who bought a floating-rate security and wishes to establish a minimum periodic cash flow on his investment could:

A. buy an interest-rate floor.

B. sell an interest-rate floor.

C. sell an interest-rate cap.   

The buyer of a floor will receive a payment when the floating rate is below the floor rate, effectively establishing a minimum rate on the floating rate security.  

Beispiel

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Example:

Buying an interest-rate cap and selling an interest-rate floor is equivalent to:

A. buying a series of interest-rate puts and selling a series of interest rate calls.

B. buying a series of interest-rate calls and selling a series of interest-rate puts.

C. buying a series of interest-rate puts and calls.  

A cap is equivalent to a series of (long) interest-rate calls and selling a floor is equivalent to selling a series of interest-rate puts.