Question #8 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 4

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Shared Context

- Which of the following best explains the difference between an interest rate put option and a put option on a fixed income security? The interest rate put option value: A) decreases if interest rates increase just as the value of a put option on a fixed income security decreases. B) decreases if interest rates increase while the value of a put option on a fixed income security increases if interest rates increase. C) increases if interest rates increase just as the value of a put option on a fixed income security increases.

Question

A LIBOR based floating rate bond combined with a LIBOR based collar (a short position in an interest rate cap and a long position in an interest rate floor both at the same strike rate) is equivalent to a:

Answer Choices:

A. pay-fixed swap position

B. fixed-rate bond

C. call option on a bond

Explanation

The effective rate above the cap strike and below the floor strike, when combined with the floating rate on a bond, is constant.

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