Interest Rate Call Option

Finance Allah Shmoop What are interest rate options All right

people you may need a big loan in three years

It's all about the storms And the big sees you

know with the amount of destruction they'll do to the

oil rigs you manage out there right you big oil

company Global warming has in fact changed weather patterns So

you have no idea if you'll actually need five billion

dollars in debt to buy and or build a new

one But today you mister or missus or Miss CEO

today interest rates are cheap The Fed is almost giving

away money in two and a half percent interest which

means that you can get a loan at Summit for

ish percent interest rate since so much money is involved

here like five billion dollars Well the move of one

percent or one hundred basis points is big and times

were good now and well you really want certainty So

in order to reduce risk you buy an interest rate

option that is You pay one hundred million dollars for

the right three years from now too Then get alone

of call it three billion dollars and note that you

don't have to get the full five billion dollars if

rates go up in the last two billion is expensive

money while fen you figure inflation has hit big time

and you can just well raise prices on oil and

you know or your services to the big oil Cos

right because that's what you do for a living That

hundred million dollars is a call option on future interest

rates that well may or may not be there right

Like it might expire worthless Or it might be worth

a fortune if rates or seven eight nine percent So

what happens if the Fed doesn't budge and rates are

identical in three years Toe what they are today you

lose it All right You lose all hundred million dollars

for that call option You bought Goldman Sachs or Morgan

Stanley or whatever Big Bank took the risk on the

other end of that trade Just made one hundred very

large just for you know being there But you don't

feel bad about it Why Well because interest rates are

still then super cheap At four percent it's kind of

like term life insurance only for the finance world Piccoli

for big oil companies or big capital expense kind of

cos every month that goes by and you lose the

fifty eight bucks you spent on that million dollar policy

you personally bought for your wife and kids If you

get hit by a bus well you feel good to

have wasted that fifty eight dollars because well the alternative

is you know that you don't have a life You

know we don't just mean that Then your social calendar's

empty And your best friends are your Star Wars action 00:02:26.92 --> [endTime] figures no