All Else Equal, What Effect Will an Increase in the Risk-Free

question 18

Essay

All else equal, what effect will an increase in the risk-free rate of interest have on the
hedge ratio? Explain.

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Definitions:

Liquidity Premiums

Additional yield that investors require to hold securities with lower liquidity, compensating them for the higher cost and difficulty of trading such securities.

Future Expected Short Rates

The anticipated interest rates for short-term debt instruments in the future, important for forecasting and investment strategies.

Forward Rate

An agreed-upon interest rate for a financial transaction that will occur in the future, used in forward contracts and rate agreements.

Zero-coupon Bond

A bond that does not pay periodic interest and is sold at a discount from face value; its return comes from the difference between the purchase price and the face value paid at maturity.