A long position in an interest rate call would be appropriate for which of the following situations:
A)a bond trader expects falling interest rates
B)a party holding a short position in Eurodollar futures is concerned about losing money
C)a borrower expects rising interest rates
D)a lender expects rising interest rates
E)a derivatives dealer is exposed to the risk of falling interest rates

Question

Quizplus · Accepted Answer

A long position in an interest rate call option gives the holder the right, but not the obligation, to benefit from rising interest rates by allowing them to borrow at a lower rate than the market rate if interest rates rise above the strike price of the option. Therefore, it would be appropriate for:
C) a borrower expects rising interest rates
In this situation, the borrower is concerned that rising interest rates will increase the cost of borrowing. By taking a long position in an interest rate call, the borrower can lock in a maximum interest rate for future borrowing. If the market rates exceed the strike price of the call option, the borrower can exercise the option and borrow at the lower strike rate, thus hedging against the risk of rising interest rates.
The other options are not appropriate for a long position in an interest rate call:
A) A bond trader expecting falling interest rates would more likely benefit from a long position in the bonds themselves or possibly an interest rate put option, which would increase in value as interest rates fall.
B) A party holding a short position in Eurodollar futures concerned about losing money from rising interest rates would be more likely to take a long position in an interest rate put option to hedge against that risk.
D) A derivatives dealer exposed to the risk of falling interest rates would hedge with an interest rate put option or other instruments that benefit from falling rates, not a call option.

A Long Position in an Interest Rate Call Would Be