A company requires short term and long term finances to cover its assets and operations. When the financing is done through loans or debt the factor of interest rates has to be considered. In a lot of circumstances the interest rate is tied to a benchmark such as LIBOR or EURIBOR. The lending institutions usually set an interest rate adding one or two percent points to this benchmark. In the given example AABC firm borrowed €25 million for two years and the interest charged to the company is 3 months EURIBOR plus 200 basis points or two percentage points.
This means the interest charge to the company would change when the EURIBOR fluctuates from quarter to quarter. This would leave the firm vulnerable to changes in the interest rate and quite risky as the interest payment would be increased over time. The company can reduce this risk through hedging in the interest rate futures market which is discussed here. There are also some strategies available to investors for making profits in the derivatives market such as the options market. Some strategies of trading in the options market are long-straddle, short-straddle, long-strangle and short-strangle.
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