You manage a $100million bond portfolio (actual, current value) with a modified duration of 8. You’re worried about future Federal Reserve policy and you want to use interest rate options to protect your portfolio from a potential increase in rates of a half a percent before you sell your portfolio. The current ‘at the money’ (strike = current rate) call option on 20-year bonds with a yield of 5% have a premium of 2. How many option contracts should you buy to protect yourself against this potential interest rate increase? What is the cost of this ‘insurance policy’? How is using interest rate options different from using interest rate futures in an uncertain interest rate environment?
You manage a $100million bond portfolio (actual, current value) with a modified duration of 8. You’re worried about future Federal Reserve policy and you want to use interest rate options to protect your portfolio from a potential increase in rates of a half a percent before you sell your portfolio. The current ‘at the money’ (strike = current rate) call option on 20-year bonds with a yield of 5% have a premium of 2. How many option contracts should you buy to protect yourself against this potential interest rate increase? What is the cost of this ‘insurance policy’? How is using interest rate options different from using interest rate futures in an uncertain interest rate environment?
Chapter5: The Time Value Of Money
Section: Chapter Questions
Problem 11P
Related questions
Question
You manage a $100million bond portfolio (actual, current value) with a modified duration of 8. You’re worried about future Federal Reserve policy and you want to use interest rate options to protect your portfolio from a potential increase in rates of a half a percent before you sell your portfolio. The current ‘at the money’ (strike = current rate) call option on 20-year bonds with a yield of 5% have a premium of 2. How many option contracts should you buy to protect yourself against this potential interest rate increase? What is the cost of this ‘insurance policy’? How is using interest rate options different from using interest rate futures in an uncertain interest rate environment?
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 3 steps
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course…
Finance
ISBN:
9781337395083
Author:
Eugene F. Brigham, Phillip R. Daves
Publisher:
Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course…
Finance
ISBN:
9781337395083
Author:
Eugene F. Brigham, Phillip R. Daves
Publisher:
Cengage Learning
