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Hi,John,
One question from Kaplan Revision kit:
Which of the following best describes an interest rate option?
A.A right but not an obligation to buy or sell interest rate futures
B.An obligation to obtain a loan at an agreed interest rate at a future date
C.A right but not an obligation to obtain a loan (or deposit) at a future date
D.A right but not an obligation to an agreed interest rate on a notional loan or deposit
the correct answer given is A.
I remember that the interest rate option is different from the option on interest rate future contract.
could you explain if the “correct answer” is correct? thank you!
A is the correct answer.
I think that you are confusing it with Interest Rate Guarantees, which are like options but are arranged directly with the bank.
Interest rate options are the right to buy or sell interest rate futures at a fixed price.
thank you! John
according to BPP study text book:
“An interest rate option grants the buyer of it the right, but not the obligation, to deal at an agreed interest rate (strike rate) at a future maturity date (the expiry date for the option).
On the date of expiry of the option, the buyer must decide whether or not to exercise the right.”it seems that the “interest rate option” in the context is equivalent to the interest rate guarantee as the IRG was not mentioned in the BPP study text.
now I’m confused with the term”interest rate option”.is it an alternative expression to IGR?
or it should be treated as the options for future contract?
and if it should be exactly distinguished in the exam?
No. As wrote in my previous reply, an interest rate guarantee is (as I explain in my free lectures) a private arrangement with the bank which limits the interest rate. It is effectively an option because you do not have to exercise the right, but it is called an interest rate guarantee.
Interest rate options are the right to buy (or sell) interest rate futures. They are traded on the exchanges and have the effect of limiting the exchange rate.
These are both explained in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
You will not be examined in detail on IRG’s or interest rate options in Paper FM – you are only expected to be aware of the various ways of managing interest rate risk. It is in Paper AFM then they are examined in detail.
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