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In relation to the use of derivatives by Peony Co, which of the following statements is correct?
A Interest rate options must be exercised on their expiry date, if they have not been exercised before then
B Peony Co can hedge interest rate risk on borrowing by selling interest rate futures now and buying them back in the future
C An interest rate swap is an agreement to exchange both principal and interest rate payments
D Peony Co can hedge interest rate risk on borrowing by buying a floor and selling a capCorrect Answer is B.
I did D. I was not able to understand why D is wrong and B is correct.If you are borrowing money then you are worried about interest rates increasing.
If interest rates increase then the futures price falls and you make a gain by selling now and buying back in the future.I explain all this in my free lectures on interest rate risk management.
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