This preview shows page 1. Sign up to view the full content.
Unformatted text preview: te a call -C –E +B C E C
B B B B E
+C –B +E 59 Put Options on Bonds
Buy a Put
P Write a Put -P-B+E
B B B
B E B +P-E+B 60 Example-Bank
Assets 100 Liabilities
10 Duration of Assets = 5 yrs, Duration of Liabilities= 3 yrs
Current rate = 10%,
Δ Equity if Expect the interest rates to increase by 1%?
ΔE = - [DA - DL * (L/A)] *A *Δr/(1+r) 61 Which Option to use?
Concern? Lose $ if rates increase
Position in the option Market
Rule : Make $ in the option Mkt if rates increase
Write a Call Buy Put B(r) B(r) B(r) B(r) As rate increases,
62 D. Hedging using Interest Rate Swaps
• Agreement between two parties to exchange,
over a fixed horizon, cash flows accruing on a
notional principal amount
• underlying debt or asset not swapped Two major types:
Interest Rate Swap
exchange of fixed interest rate payments with
floating rate payments
exchange of one currency’s interest rate and
principal cash flows for another’s 64 Interest Rate Swaps Terminology
agrees to make fixed interest payments and
receive floating interest payments
swap seller agrees to make floating interest
payments and receive fixed interest payments
Either side could actually deal with dealer The...
View Full Document