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Dear Sir, Good morning,
Here is the question:
What type of option would a borrower use to hedge against interest rate rises and when would it be abandoned?
A. Put option, abandon when rates fall
B. Call option, abandon when rates fallI choose B, but the answer is A. Please kindly tell me whether I am right or wrong and why.
Thanks so much.
The answer certainly is A.
If the interest rate rises the futures price will fall. A put option gives you the right to sell a future at a fixed price, and so if futures prices fall then you buy at the low price and sell at the strike price and make a profit.
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