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Hedging interest rate risk

5.2 Traded options hedging calculations

1 Now – set up the hedge

– Call or put options? Put for borrowings, call for deposits

– Which expiry date? Same as for futures

– How many contracts? Same as for futures

– Which strike price? Choose the most beneficial

2 Contact the exchange and pay the premium.

3 Future transaction date – financial result is the total of:

– the value of the transaction using the market rate of interest on
the transaction date, adjusted for:

 futures market profit (found by exercising the option and

then closing out the futures contracts). Note that this will

either be zero (if we let the option lapse), or a profit if we
choose to exercise the option.

Illustrations and further practice

Now try TYU 5 and TYU 6 in Chapter 11

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