Risk Management (7) Flashcards
What can borrowers do in interest rate options?
Can set a maximum on the interest they have to pay by buying put options
What can lenders/depositors do in interest rate options?
Set a minimum on the interest they receive by buying call options.
What is a cap?
If the reference interest rate rises above a predetermined level, the financial institution pays the difference to the company
What is a floor?
If the reference interest rate falls below a predetermined level, the financial institution pays the difference to the company
What is a collar?
A combination of a cap and a floor keeps an interest rate between an upper and a lower limit
What does a borrower do in options?
Buy a cap and sell a floor, thereby offsetting the cost of buying a cap against the premium received by selling a floo
What does an investor do in options?
Buy a floor and sell a cap
What is an interest rate swap?
An exchange between two parties of interest obligations or receipts in the same currency on an agreed amount of notional principal for an agreed period of time
What is a plain vanilla swap?
Where fixed interest payments based on a notional principal are swapped for floating interest payments based on the same notional principal.
