Chapter 41. Interest Rate Options and Related Products
FRANK J. FABOZZI, PhD, CFA, CPA
Professor in the Practice of Finance, Yale School of Management
STEVEN V. MANN, PhD
Professor of Finance, Moore School of Business, University of South Carolina
MOORAD CHOUDHRY, PhD
Head of Treasury, KBC Financial Products, London
Abstract: Interest rate options and related option-type products are used by market participants to control interest rate risk. There are exchange-traded and over-the-counter interest rate options. The interest rate options product most traded on exchanges is a futures option. Over-the-counter options include options on specific securities, spread options, compound options, caps, and floors. With all over-the-counter products there is counterparty risk faced by the buyer of the option or option-related product.
Keywords: option, American option, European option, Bermudan option, exotic options, nonstandard options, exchange-traded options, over-the-counter options, dealer options, futures options, counterparty risk, spread options, compound option, split-fee option, front fee, back fee, cap, floor, caplets, captions, flotions
An interest rate option is a derivative instrument that differs from an interest rate forward contract, a futures contract, and a swap in terms of its risk and return characteristics. As such, an interest rate option can be employed to control interest rate risk in ways that are either not possible or too costly to achieve using forwards, futures, or swaps. ...
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