ACCA Financial Management (F9) Certification Practice Exam

What does an interest rate option grant to the buyer?

1. The obligation to borrow at a fixed rate

2. The right to deal at an agreed interest rate

3. The right to exchange future payments

4. The obligation to maintain a certain level of capital

The correct answer is: The right to deal at an agreed interest rate

An interest rate option grants the buyer the right, but not the obligation, to enter into a borrowing or lending agreement at a predetermined interest rate for a specified period. This means that the buyer can choose whether to proceed with the agreement depending on market conditions. Essentially, it allows the buyer to hedge against fluctuations in interest rates or to speculate on future movements, giving them flexibility. This concept is particularly valuable in financial management as it offers a way to manage interest rate risk without imposing any mandatory transactions on the buyer. The buyer can exercise their right if it is beneficial to do so, or let the option lapse if market rates are more favorable than the agreed-upon rate. This flexibility is fundamental to how options operate, contrasting with outright obligations that would require action regardless of circumstances.