Floating interest rates vary based on an index like LIBOR plus a spread. This means the interest rate on loans and bonds fluctuates over time based on market conditions. When interest rates rise, it increases the fixed costs for companies in the form of higher interest payments. This reduces earnings per share (EPS) as less profits are left for shareholders. The document analyzes how changes in floating interest rates impact financial leverage and EPS for companies through two scenarios. It finds that financial leverage is affected to a larger degree by changes in floating versus fixed interest rates, as the percentage change in leverage is not the same when rates rise or fall.
Interest-rate risk substantially affect the values of the assets and liabilities of most corporations and is often a dominant factor affecting the values of pension funds, banks and many other financial intermediaries.
Interest-rate risk substantially affect the values of the assets and liabilities of most corporations and is often a dominant factor affecting the values of pension funds, banks and many other financial intermediaries.
A bond that releases interest payments on the basis of a particular price index is known as Indexed Bonds or Index-Linked Bonds or Inflation-Indexed Bonds.
To know more about it, click on the link given below:
https://efinancemanagement.com/sources-of-finance/indexed-bonds-meaning-examples-advantages-and-more
BONDS, FEATURES OF BONDS, BOND VALUATION, MEASURING YIELD, ASSESSING RISK, TYPES OF LONG- TERM DEBT INSTRUMENTS, SERIAL BONDS, TYPES OF RISK, SEMI- ANNUAL BONDS, YIELD TO CALL, YIELD TO MATURITY, DEFAULT RISK & FACTORS AFFECTING DEFAULT RISK & BOND RATINGS, etc.
http://www.options-trading-education.com/24091/interest-rate-options/
Interest Rate Options
In interest rate options trading traders are positioning themselves for a faster than previously expected rise in interest rates. As reported in Bloomberg, a faster rate rise is expected as evidenced by a change of the put to call ratio on interest rates from 1.9 to 3.2.
Options Wager
Investors in put options are betting that market participants will raise their expectations for the level of the federal funds rate in 2017. They are wagering that Fed policy makers meeting this week will forecast a higher rate at the end of 2017 than most investors now predict.
As of Sept. 10, there were 3.2 active put options for every active call option, according to data from CME Group Inc. That’s up from a ratio of 1.9 on the final day of the FOMC’s July 29-30 gathering.
Using short-term options on the contract allows traders to place a bet on a policy surprise from the Fed at a relatively low cost and limits the damage in case the trade doesn’t work out, because holders of the options can only lose as much as they paid for them.
The Federal Reserve is phasing out its quantitative easing stimulus program. The $85 billion a month purchase of bonds has been reduced and the general consensus is that it will be done by the next month. Federal Reserve officials have stated that they will keep interest rates low as long as it takes for the economic recovery to be secure. But, as employment figures rise speculation is that the Fed will push rates up soon rather than later. Interest rates options are a practical way to profit from such a move.
Interest Rate Options
An Interest rate option is a specific financial derivative contract. Its value is based is based on interest rates such as the yield on 10 year treasury notes. Just like with equity options one can purchase calls or puts. Traders purchases calls if they believe that rates will go up and puts if they believe that rates will fall. A useful reference is the CME Group Options Open Interest Rate Tool. Rate curves displayed include the following:
Eurodollar
1 Year Mid Curve
2 Year Mid Curve
3 Year Mid Curve
4 Year Mid Curve
5 Year Mid Curve
2 Year Note
5 Year Note
T bond
Ultra
As will all options trading it is smart to focus on one aspect of the market with which you are familiar in trading interest rate options.
Profitable Interest Rate Trading
There are many profitable options strategies that can be applied to interest rate options trading as well as trading other kinds of options. Basically interest rate options trading has to do with forecasting what the Federal Reserve will do with rates and other basic economic factors that tend to drive rates up and down. Short term interest rate options trading has to do with reading market sentiment using technical analysis tools in order to profit from the inefficiency inherent in all markets.
A bond that releases interest payments on the basis of a particular price index is known as Indexed Bonds or Index-Linked Bonds or Inflation-Indexed Bonds.
To know more about it, click on the link given below:
https://efinancemanagement.com/sources-of-finance/indexed-bonds-meaning-examples-advantages-and-more
BONDS, FEATURES OF BONDS, BOND VALUATION, MEASURING YIELD, ASSESSING RISK, TYPES OF LONG- TERM DEBT INSTRUMENTS, SERIAL BONDS, TYPES OF RISK, SEMI- ANNUAL BONDS, YIELD TO CALL, YIELD TO MATURITY, DEFAULT RISK & FACTORS AFFECTING DEFAULT RISK & BOND RATINGS, etc.
http://www.options-trading-education.com/24091/interest-rate-options/
Interest Rate Options
In interest rate options trading traders are positioning themselves for a faster than previously expected rise in interest rates. As reported in Bloomberg, a faster rate rise is expected as evidenced by a change of the put to call ratio on interest rates from 1.9 to 3.2.
Options Wager
Investors in put options are betting that market participants will raise their expectations for the level of the federal funds rate in 2017. They are wagering that Fed policy makers meeting this week will forecast a higher rate at the end of 2017 than most investors now predict.
As of Sept. 10, there were 3.2 active put options for every active call option, according to data from CME Group Inc. That’s up from a ratio of 1.9 on the final day of the FOMC’s July 29-30 gathering.
Using short-term options on the contract allows traders to place a bet on a policy surprise from the Fed at a relatively low cost and limits the damage in case the trade doesn’t work out, because holders of the options can only lose as much as they paid for them.
The Federal Reserve is phasing out its quantitative easing stimulus program. The $85 billion a month purchase of bonds has been reduced and the general consensus is that it will be done by the next month. Federal Reserve officials have stated that they will keep interest rates low as long as it takes for the economic recovery to be secure. But, as employment figures rise speculation is that the Fed will push rates up soon rather than later. Interest rates options are a practical way to profit from such a move.
Interest Rate Options
An Interest rate option is a specific financial derivative contract. Its value is based is based on interest rates such as the yield on 10 year treasury notes. Just like with equity options one can purchase calls or puts. Traders purchases calls if they believe that rates will go up and puts if they believe that rates will fall. A useful reference is the CME Group Options Open Interest Rate Tool. Rate curves displayed include the following:
Eurodollar
1 Year Mid Curve
2 Year Mid Curve
3 Year Mid Curve
4 Year Mid Curve
5 Year Mid Curve
2 Year Note
5 Year Note
T bond
Ultra
As will all options trading it is smart to focus on one aspect of the market with which you are familiar in trading interest rate options.
Profitable Interest Rate Trading
There are many profitable options strategies that can be applied to interest rate options trading as well as trading other kinds of options. Basically interest rate options trading has to do with forecasting what the Federal Reserve will do with rates and other basic economic factors that tend to drive rates up and down. Short term interest rate options trading has to do with reading market sentiment using technical analysis tools in order to profit from the inefficiency inherent in all markets.
A common feature of both FMPs (Fixed Maturity Plans) and FDs (Fixed Deposits) is that investors know in advance how much return they will earn on maturity. The difference here is that while the returns on FDs are assured, returns on FMPs are indicative.
This is to compare the Returns of Fixed Deposits and Debt Oriented Hybrid Funds [Capital Protection Oriented Fund / Scheme (CPOF), Mutual Fund Monthly Income Plan / Scheme (MIP), Equity Savings Funds], to demonstrate how the latter is better.
https://rb.gy/n89u77
Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. Discuss the general features,
yields, prices, ratings, popular types, and international issues of
corporate bonds. Review the legal aspects of bond financing and bond cost.
Distinction Between Interest Rates and Returns, Distinction Between Real and Nominal Interest Rates, Relationship Between Price and Yield to Maturity, Yield to Maturity: Bonds, Yield to Maturity: Loans
5. Spread of interest rate Margin over the base rate. Floating interest rate ={ base rate +spread ; if interest rate rises base rate -spread ; if interest rate falls } Consider eg. A 5 yr. loan is priced at 6month LIBOR + 2.5%. at the end of each 6month period, the rate for the following period= LIBOR at that point + (/- ) spread
10. What is financial leverage? Is the leverage that occurs due to the presence of fixed financial charges in a firm. Due to interest rates to bonds ,debentures and preference dividends. Here,Fixed charges do not vary with EBIT. Quantitatively, DFL= % change in EPS/%changeinEBIT
11. Relationship between financial leverage and interest rate Rise in interest rate implies rise in fixed cost and hence rise in financial leverage. DFL rises ,EPS falls
12. Have you ever thought what will happen to financial leverage if interest rate is floating ? Remember before coming to ICFAI hyderabad, we had to take a loan … Hardly, 9 months …. Interest rates in banks was floating with full vigor……..what could be the leverage then………
17. …contd. A company worth Rs. 10,00,000 shares Rs. 8,00,000 bonds Rs. 2,00,000 bonds interest rate ---- floating EBIT (expected value) 50,000 tax @35% on PBT No preference shares issued no. of outstanding shares 5000
18.
19. Inference from scenario 1 Interest rate changes monthly from 5.75% to 8.4%. Interest rises from 11,500 to 16,800 EBIT level kept same Investors will be more interested to invest in debts than in shares debt- equity proportion rises As the company now pays more money as returns to the financial institutions or bond/debenture holders, hence less money is left with the company to pay to the shareholders. Hence , EPS declines from 5.005 to 4.316 Rate of fall of EPS is 13.76%
20. scenario2 company issues more bonds than share bonds Rs. 6,00,000 shares Rs. 4,00,000 EBIT(expected value) RS.1,50,000 (rising in the same proportion as bond value)
21.
22. Inference of scenario2 Interest rate rises from 8.56% to 10.5% Interest rises from 51,360 to 63,000 EPS falls from 12.8232 to 11.31 Rate of fall of EPS is 11.8%
23. Inference of Scenarios 1 &2 Debt-equity proprtion changes from 1:4 to 3:2 Firm’s expected earnings increase in same proportion. Highly floating rate- rises from 5.75% to 10.5% Interest- fixed cost rises from 11,500 to 87,000 EPS falls with a rate of 13.76% in scn.1 while falls with a rate of 11.8% in scn.2 Hence, as interest rate rises, EPS falls with a falls with a falling rate.
24.
25. …contd. Case 1 % change in EBIT =+ 40% % change in EPS = +39.7052% DFL = % change in EPS/%change in EBIT = 39.7/40 = 0.9925
26. case 2 % change in EBIT= -40% % change in EPS = -39.87% DFL = % change in EPS/ % change in EBIT 39.87/40 = 0.9965 …contd.
27.
28. Interest rate is also increased or decreased by 40% to both sides.