Chipman Products Company will suffer an increase in borrowing costs if the thirteen-week Treasury bill rate increases in the next six months. Chipman Products is willing to accept the risk of small changes in the thirteen week T-bill rate but wishes to avoid the potential losses associated with large changes. The company plans to hedge its risk exposure using an interest rate collar.
If the company buys a call option on the thirteen-week T-bill rate with a strike price of 60 and sells a put option with a strike price of 50, describe how this strategy will limit the company's exposure to changes in the T-bill rate. The premium on the call is 0.75, and the premium on the put is 0.85.
What is the company's profit (or loss) in the option market if the T-bill rate is 4.5 percent in fi ve months?
If the T-bill rate is 5.5 percent? If the T-bill rate is 6.5 percent?