LOS c: Compare and contrast interest rate options to forward rate agreements (FRAs).

Q1. A forward rate agreement is equivalent to:

A)   a long interest rate call and a written interest rate put.

B)   either an interest rate put or an interest rate call.

C)   a swap.

Q2. Which combination of interest rate options most likely has the same pattern of payoffs as the short position in a forward rate agreement?

                 Interest rate call option                 Interest rate put option

A)             Long                                            Short

B)             Long                                            Long

C)             Short                                            Long

Q3. A long interest rate call and a short interest rate put is an equivalent position to:

A)   a pay-fixed interest rate swap.

B)   a long position in a forward rate agreement.

C)   a short position in a forward rate agreement.

Q4. A short position in a forward rate agreement is equivalent to:

A)   writing an interest rate put and buying an interest rate call.

B)   writing an interest rate call and buying an interest rate put.

C)   writing both an interest rate put and an interest rate call.

LOS c: Compare and contrast interest rate options to forward rate agreements (FRAs). fficeffice" />

Q1. A forward rate agreement is equivalent to:

A)   a long interest rate call and a written interest rate put.

B)   either an interest rate put or an interest rate call.

C)   a swap.

 Correct answer is A)

A long forward rate agreement is equivalent to a call (profits when interest rates go up) and a written put (losses when interest rates go down).

Q2. Which combination of interest rate options most likely has the same pattern of payoffs as the short position in a forward rate agreement?

                 Interest rate call option                 Interest rate put option

A)             Long                                            Short

B)             Long                                            Long

C)             Short                                            Long

Correct answer is C)

A short position in an FRA will have a positive payoff when the reference rate is less than the contract rate, and a negative payoff when the reference rate is greater than the contract rate, at expiration. A short interest rate call will have a negative payoff when the reference rate is greater than the strike rate, and a long put will have a positive payoff when the reference rate is less than the strike rate.

Q3. A long interest rate call and a short interest rate put is an equivalent position to:

A)   a pay-fixed interest rate swap.

B)   a long position in a forward rate agreement.

C)   a short position in a forward rate agreement.

Correct answer is B)

A long call and short put on interest rates is equivalent to a long position in a forward rate agreement. Both gain when forward rates increase and decline in value when interest rates decrease.

Q4. A short position in a forward rate agreement is equivalent to:

A)   writing an interest rate put and buying an interest rate call.

B)   writing an interest rate call and buying an interest rate put.

C)   writing both an interest rate put and an interest rate call.

Correct answer is B)

A short position in a forward rate agreement is an obligation to make a hypothetical loan at the contract rate and will be profitable when the forward rate falls. An equivalent position using interest rate options is to buy a put and write a call.

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