At certain intervals, generally every six months, the market interest rate is compared with the interest rate purchased, and any difference in rates is paid. A forward rate agreement is a hedge purchased by the investor. If interest rates rise by the time the investment is made, the forward rate agreement will profit. interest rate, %/year (initial rate = 10%) end−of−period value with zero net initial investment Strangely enough, having a at yield curve that moves up and down implies there is arbitrage! This is related to convexity of the bond price in the interest rate. The simplest way to hedge interest rate risk in a portfolio is to purchase short-term securities whose value will not fluctuate significantly given higher interest rates. Another technique is to hedge this risk by purchasing put options on long-term debt (especially even longer-term debt than the debt in the portfolio). These options will pay off if interest rates drop, and if they rise, the rise in the value of the bonds will pay for the costs of the put options. Hedging complicated risks