Question #18 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 9

Status: Unattempted

Correct Answer: A

Shared Context

- Williamson is very interested in the total return swap. He asks Potter how much it would cost to enter into this transaction. Which of the following is the most likely cost of the swap at inception? A) $45,007. B) $0. C) $340,885.

Question

Potter analyzes alternative hedging strategies to address the risk of the bank's large floating- rate liability. Which of the following is the most appropriate transaction to efficiently hedge the interest rate risk for the floating rate liability without sacrificing potential gains from interest rate decreases?

Answer Choices:

A. Sell an interest rate floor and buy an interest rate cap

B. Sell an interest rate cap

C. Buy an interest rate cap

Explanation

Buying a cap, combined with a floating rate liability, limits the exposure to interest rate increases (i.e., no exposure to interest rate increases above strike rate). The floating rate borrower will still benefit from interest rate decreases.

Actions

Practice Flashcards