Leando Enterprises has a variable rate loan and wants to lock in the rate so that the firm is in essence paying no more than 8.5% nor less than 7.5%. To do this, the firm needs to ____ a call and ____ a put option on interest rates.
A) buy; buy
B) buy; sell
C) buy; ignore
D) sell; buy
E) sell; ignore

Question

Quizplus · Accepted Answer

To lock in the rate so that it does not exceed 8.5%, the firm needs to buy a call option on interest rates, which gives it the right to borrow at this rate even if rates go higher. To ensure it does not pay less than 7.5%, the firm needs to sell a put option on interest rates, which obligates it to lend at this rate even if rates go lower. This combination effectively locks in the interest rate within the desired range.

Leando Enterprises Has a Variable Rate Loan and Wants to Lock