Below are some excerpts from an article titled “It’s Boom Time for Bond Options as Interest-Rate Hedges Bloom,” published in the November 8, 1990, issue of The Wall Street Journal.
Answer each question after each below quote.
(a) “The threat of a large interest-rate swing in either direction is driving people to options to hedge their portfolios of long-term Treasury bonds and medium-term Treasury notes,” said Steven Northern, who manages fixed-income mutual funds for Massachusetts Financial Services Co. in Boston. Why would a large interest rate swing in either direction encourage people to hedge?
(b) “If the market moves against an option purchaser, the option expires worthless, and all the investor has lost is the relatively low purchase price, or ‘premium,’ of the option.” Comment on the accuracy of this statement.
(c) “Futures contracts also can be used to hedge portfolios, but they cost more, and there isn’t any limit on the amount of losses they could produce before an investor bails out.” Comment on the accuracy of this statement.
(d) “Mr. Northern said Massachusetts Financial has been trading actively in bond and note put options. ‘The concept is simple,’ he said. ‘If you’re concerned about interest rates but don’t want to alter the nature of what you own in a fixed-income portfolio, you can just buy puts.’ ” Why might put options be a preferable means of altering the nature of a fixed-income portfolio?