2019 Level 2 Mock Exam a_am_Problem 39: The solution states “Long put options hedge against rising interest rates”. I would have thought “Long **call** options hedge against rising interest rates” because they increase in value with rising interest rates (and rising borrowing costs). Anybody else disagrees w/ the official solution? I picked ‘A’, not ‘B’.

I don’t have access to the mock.

This is true if the instrument is a **put option on bonds**. When interest rates rise, bond value declines. Put option on bond is exercised when bond price drops below option strike price.

This is true if the instrument is an **interest rate call option** (or call option on interest rate). When interest rate rises above the strike rate, call option can be exercised.

Thanks fino_abama. The mock exam problem refers to the borrower’s protection against rising rates for a variable rate loan to be taken out 6 months later. Appears to me that long call options (or short puts) are the appropriate hedge, but not long puts as the solution states.

Okay. I got my student to show me the mock exam.

In usual cases you are right but take note that in this case and this question, the instrument is on **Eurodollar futures options**, and the specifications are different.

For Eurodollar futures, its price is defined as:

Futures Price = 100 - LIBOR3M

For example, if 3-month LIBOR = 4% then the futures price = 100 - 4 = 96

Let’s assume that 3-month LIBOR then increases to 7%, so the Eurodollar futures price would drop to 93 (= 100 - 7).

*Conclusion*: When interest rates **increase**, the Eurodollar futures price **declines**.

So the question is, how do you **benefit** from the **option** on Eurodollar futures when the futures **price declines**?

**LONG PUT OPTIONS on EURODOLLAR FUTURES**

Hope that clears the doubt.

Thanks very much, got it. It is a derivative on a derivative. The borrowers needs protection against rising rates i.e. against falling Eurodollar futures prices. --> correct option hedge = long put options.

You got it