Question

A portfolio manager has a large position in the preferred stock of XYZ Corporation. The manager is concerned that market interest rates are going to rise. To hedge the preferred stock position, the manager should:

Answer 1

Answer:

To hedge the preferred stock position, the manager should: Buy tyx calls

Explanation:

When market interest rate rise preferred stock drop. To hedge using interest rate index option, the contract must offer an offsetting profit during a period of rising interest rates. Therefore buy TYX calls. These will continue to give ever increasing profit as market interest rate continue to rise. And it will offset the ever increasing loss that would be incurred on the XYZ preferred stock position as the market interest rate continues rising.

The hedge is that Any loss on preferred stock position would be offset by corresponding gain on the long interest rate index call position.