Interest Rate Risk Management OT

Question 1

If we borrow money/

Answer 1

We pay interest rate, but interest rate can also increase or decreasee

Question 2

Ways of borrowing money

Answer 2

Floating rate
Fixed rate

Question 3

Borrowing at floating rate?

Answer 3

Charge actual rate from day to day. No idea next week

Question 4

Borrowing at fixed rate?

Answer 4

Interest rate is fixed at the start of the loan

Question 5

Risk with fixed rate?

Answer 5

If I need to borrow $100000 in 3 months time with interest rate 10%. Risk is what will the interest rate in 3 months when I’m borrowing money

Question 6

Forward rate agreement (FRA)

Answer 6

Interest rate fixed today for a loan starting on a fixed future date

Question 7

Example of FRA

Answer 7

Borrow $100000 for 3 - 9
3 is start date of loan
9 is end date of loan

Question 8

If bank quotes 10% at start of loan in FRA but actual rate is 11%

Answer 8

Lender tells actually pay 11%, bank gives me back 1% to get to 10%

Question 9

Interest rate guarantee (IRG)

Answer 9

I tell the bank the maximum of what I pay is

Question 10

Example of IRG

Answer 10

Borrow $100000 3 - 9 at 10%

Bank then charges a premium at $5000

Question 11

At start of loan in IRG? (interest rate up or down)

Answer 11

Actual interest rate 12% when I agree to borrow at 10%. Use IRG at 10%

Actual interest rate 8% when I agree to borrow at 10%. Pay 8%

Question 12

Borrowing money through IRG?

Answer 12

Want to fix maximum interest rate “cap”

Question 13

Depositing money through IRG?

Answer 13

Want to fix a minimum rate “floor”

Question 14

Interest rate futures concept?

Answer 14

Higher interest rate lowers the futures price

Question 15

Cancel risk from interest rate futures?

Answer 15

Start a futures deal today

Question 16

How can futures deal remove risk?

Answer 16

Sell futures today and then buy on date of transaction

Question 17

If we borrow in 6 months but interest in futures is only 3 months

Answer 17

(6/3) * amount of loan

Question 18

Issue with futures price?

Answer 18

They aren’t precise, fluctuations happen

Question 19

When may floating rate > fixed?

Answer 19

If income goes up and down through interest rates. Borrowing should be floating to take advantage of fluctuations

Question 20

Interest rate swap?

Answer 20

Two companies both borrowing money but they swap the interest rate payments