- November 20, 2021 at 9:31 am #641136sadafwaheed1Member
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Hello sir . These three statements are from Kaplan exam kit . They are false but isn’t any clear explanation given in kit can you please explain me why they are false
1) interest rate floor can be used to hedge an expected increase in interest rate
2) premium on interest rate option is payable when exercised
3)standardised nature if interest rate future mean that over and under heading can be avoidedNovember 20, 2021 at 6:12 pm #641191John MoffatKeymaster
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1. An interest rate floor fixed a minimum interest rate. To protect against an increase in interest rates then we need an interest rate cap which fixed a maximum interest rate.
2. The premium on options is payable whether or not the options are exercised and is payable when the options are purchased.
3. Interest rate futures are dealt in fixed size contracts which means that usually the amount hedged will not exactly equal the transaction at risk and therefore we will have over or under hedged.
All of this is explained in my free lectures on interest rate risk management (and on foreign exchange risk management because (2) and (3) apply to both). The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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