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Derivative Products

S

Sardar

Member
Can someone please explain what the following instruments are and how they work - it is not at all clear to me

an interest rate future

buying a put option on an interest rate (this apparently caps the rate for future borrowing - but cannot understand how/why!)

buying a call option on an interest rate (collars the minimum rate for future lending - but again cannot understand how/why this is)

thanks
 
think that a specified principal applies on the interest rate in all cases,

e.g. If you have a loan of 100m and you pay floating interest rate on it, if you buy a call on the floating interest rate with exercise rate 5%, it provides a payoff if the floating interest rate is more than 5%.

e.g. if on expiry the floating rate is 6%, the payoff will be 100m x (6%-5%)= 100m x 1%

So if you add this to your loan interest payment of 100m x 6% in total you get

-100m x 6%
+100m x 1%
= -100m x 5%
 
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