7Lecture8interestrateriskIV

5 15 075 075 etc 73 e caps floors and collars

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Unformatted text preview: L <0 B RSA FRA RSL FRL Prefer to receive floating and pay fixed 70 Comparative advantage in borrowing Floating r Fixed r A L+1% 8% B L+2.5% 11% Quality Spread A-B B-A 71 Swap arrangement A Use comparative advantage Swap Swap in$ Swap out$ B Swap out$ Swap in$ 72 B A RSL RSA FRA FRL 0 1.5% 1.5% 0.75% 0.75% Etc… 73 E. Caps, Floors and Collars • Cap ~ Interest rate option Call option on “r” Buyer : right to receive interest if rSpot > rCap and nothing if r < rCap Receive rSpot -rCap If rSpot > rCap Cap Nothing If rSpot < rCap Seller : obligation to pay if the option is exercised .i.e. If rSpot > rCap 74 Graphically r rCap rSpot Receive rSpot -rCap Hedging ~ Buy an insurance against higher rates Time 75 Floor Buyer : right to receive interest if rSpot < rFloor and nothing if rSpot > rFloor Put option on “r” Seller : obligation to pay if the option is exercised 76 Graphically r Hedging ~ Buy an insurance against lower rates rSpot rFloor Receive rFloor-rSpot Time 77 Collar ~ Buy Cap and Floor r rCap rSpot rFloor Receive rSpot -rCap Receive rFloor -rSpot Time 78 Example B/S FRA RSL Buy Cap 79 Buy 2-year 9% Cap with notional value= 100 mln Year rCap rSpot 1 9% 10% 2 9% Pmt to buyer 11% 80 Example B/S RSA FRL Buy Floor 81 Buy 2-year 4% Floor with notional value= 100 mln Year rFloor rSpot 1 4% 3% 2 4% Pmt to buyer 2% 82 Example B/S RSA RSL FRA FRL Buy Collar Buy Cap 83...
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This note was uploaded on 03/12/2014 for the course FINE 442 at McGill.

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