Problem
A financial institution has a bond worth $5,000,000 (par value). They would like to sell the bond in 6 months. The bond has a duration of 6 years. It is predicted that within the next few months interest rates will rise.
i. What are two ways in which the institution can use call and put options on T-bonds to generate positive cash flows if this situation were to occur?
ii. In what situations would the bank be more exposed overall to declines in interest rates? Think in terms of repricing gap and duration gap.