A lender who is worried that its cost of funds might rise during the term of a loan it has made can hedge against this rise without eliminating the chance to profit from a decline in the cost of funds by
A)buying futures contracts on Treasury bills.
B)selling futures contracts on Treasury bills.
C)buying put options on Treasury bills.
D)buying call options on Treasury bills.

Question

Quizplus · Accepted Answer

By buying put options on Treasury bills, the lender can hedge against a rise in the cost of funds and limit its potential losses, while still benefiting from a decline in the cost of funds. Option contracts give holders the right, but not the obligation, to buy or sell the underlying security at a predetermined price and time. Buying put options on Treasury bills would allow the lender to sell the securities at a predetermined price (the strike price) if the cost of funds rises, protecting against losses. However, if the cost of funds decreases, the lender can still benefit from holding the Treasury bills without any obligation to sell them at the strike price. Buying futures contracts on Treasury bills (A) and selling futures contracts on Treasury bills (B) only offer protection against rising costs and eliminate potential gains from a decline in costs. Buying call options on Treasury bills (D) offers the right to buy, rather than sell, the securities at a predetermined price, which would not provide protection against rising costs.

A Lender Who Is Worried That Its Cost of Funds