How RFR affects call values and put values

CFA Level I Derivatives
#1

Hey

Can someone explain how an increase in RFR can increase call values and decrease put values?

Thanks alot!

#2

The easiest way to see it is to look at put-call parity:

S0 + P0 = C0 + PV(X)

If the risk-free rate increases, then PV(X) decreases; thus, either C0 must increase or P0 must decrease (or both). If the risk-free rate decreases, PV(X) increases; thus, either C0 must decrease or P0 must increase (or both).

In summary:

  • When RFR increases, call prices increase and put prices decrease
  • When RFR decreases, call prices decrease and put prices increase

I would never bother to memorize the summary; on the exam I’d write out the put-call parity formula and work it out from there.