Question #48
Reading: Reading 31 Valuation of Contingent Claims
PDF File: Reading 31 Valuation of Contingent Claims.pdf
Page: 21
Status: Unattempted
Question
Suppose a forward rate agreement (FR
Answer Choices:
A. call and a short put on MRR with a strike rate of 8% and six months to expiration
B. call and a short put on MRR with a strike rate of 8% and twelve months to expiration
C. put and a short call on MRR with a strike rate of 8% and twelve months to expiration
Explanation
Interest rate swaps can be replicated with a series of put and call positions with expiration
dates on the payment dates of the swap. For a receiver swap (where we pay floating and
receive fixed), we need an option position that pays when floating rates fall and that
requires a payment to be made when rates increase. A long interest rate put plus a short
interest rate call would accomplish this. The strike rate of the options corresponds to the
fixed rate of the FRA. The expiration of the option coincides with the MRR determination
date.