money,banking and financial markets What kind of an option should you purchase if you participate selling $1million of Treasury bonds in one year’s time wish to hedge against the risk of...
What kind of an option should you purchase if you participate selling $1million of Treasury bonds in one year’s time wish to hedge against the risk of interest rates rising?
First of all, selling the Treasury bonds could be a good idea, since rising interest rates cause the value of long-term bonds to decline. You could invest in shorter term bonds, and as the interest rate cycle nears its peak, look to get back into to longer duration bonds, as their value will go back amidst falling interest rates. Of course, as many (some experts, some not so much) are advocating these days, you could invest in precious metals, which tend to hold their value through periods of inflation.
If you want to hedge against rising interest rates, this means you want to hedge against paying more for money, even while you earn more on bonds and certificates of deposit. To offset paying more for money, you'll want to buy a call option at a set strike price that will lock in profitability and allow a long position in the Treasury market.
Another possible idea is to wait a little, because Pimco's Bill Gross is creating an ETF where people can sell and buy bonds in a very easy way over a stock exchange. To hedge on an ETF what you can do is buy the ETF and then sell a covered call. So, you would own the underlying stock (the ETF) and then collect the premium through the options contract.
Well, success in the financial game involves being ready to change in response to a bewildering array of ever-changing variables. I think many would advise, as #2 points out, that investing in gold at this time of financial uncertainty would be a very wise move. Otherwise you need to look at shorter term investments so that you can remain responsive.
At this point, interest rates usually go down instead of up. However, it could be a good idea to sell the bonds because chances are the rates have gone down as much as they are going to go and now they are starting to go up. It is still a gamble.