put call parity Lisa

prav_Cfa7

Hi guys,

could someone help me please to understand the below definition please?

"The payoffs of a short position on a FRA can be replaced by going long on interest rate put options and short on interest rate call options"

Thanks!

Lisa

Wasteoftime

I don't think its possible to explain this through put call parity. It's just a simple exercise of replicating payoffs.

Bulla564

Many thanks guys!

ramdabom

FRA pays the long when underlying asset price/interest rate goes up and pays the short when asset price/interest rate goes down. You can simulate an long on FRA by going long on call and short on put. Going long on call will pay when asset price goes up but will not get exercised if asset price goes down. Short on put will have to make payment if asset price goes down but will not be exercised if asset prices go up. Short on FRA will be exactly opposite to long on FRA. I hope this helps!

Micholien

Can any one explain this in terms of the put call parity equation...

S+p=c+X/(1+rfr)^t ?


Thanks!

rkapoor

Generally, you can replicate short forward contracts by buying a put and selling a call. I find it handy to think about these in terms of payoffs. If you are short the FRA, you have a linear payoff with respect to rates on the valuation date. That is, if you graph payoff vs. rates, you will get a straight, downward sloping line where payoff = 0 when rates = the strike. By buying the put, you replicate the positive part of this payoff diagram. By selling the call, you replicate the negative part of this payoff diagram.