Could someone help me understand the concept and use of an interest rate option?
Is it for example like this: when you’re bondholder you receive fixed interest payments from the borrower. In order to mitigate the risk of missing out on increased market interest rates you buy a interest rate call option? But how does it work when you exercise this? You get one interest payment according to the market rate and all the other are back to the fixed rate?
Or can you buy an interest call option just for ‘speculative’ reasons? So without owning the bond? But then what is the interest payment based on?
Lastly, Investopedia says: “an interest rate call option is a derivative in which the holder has the right to receive an interest payment based on a variable interest rate, and then subsequently pays an interest payment based on a fixed interest rate.” Which make it sound more like a swap, because there are payments going both ways?
As you can see… I’m lost. Thanks for your help!