Question

You have lent a floating rate loan to a borrower. Now, the interest rates are likely to decline.

Which instrument could you use to protect yourself against a risk of declining interest rates?

Select one:

a. Reverse repo

b. Short hedge in Futures

c. Interest rate Cap

d. Long hedge in Futures

e. Repo

Answer 1

Reverse repo refers to the rate at which central bank of a country borrows money from the commercial banks.

Interest Rate Cap is the limit on how high can interest rate rise n a Variable-debt.

Repo rate is the rate at which banks borrow money from the central bank.

A lender can minimize the interest rate risk by hedging in Futures.

Short hedge in Futures refers to the short position taken on the future contract. This position is taken when the user anticipates that the price of the asset will decrease.

Long Hedge is used when you anticipate that the price will go up.

In this case, since the interest rates may decline, you can protect yourself by short Hedge in Futures.

Hence, Option B is the answer.