Question #53 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

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Shared Context

- Bower is a bit puzzled about how to use caps and floors. He wonders how he could benefit both from increasing and decreasing interest rates. Which of the following trades would most likely profit from this interest rate scenario? A) Buy at the money cap and sell at the money floor. B) Sell at the money cap and at the money floor. C) Buy at the money cap and at the money floor.

Question

Bower has studied swaps extensively. However, he is not sure which of the following is the swap fixed rate for a one-year interest rate swap based on 90-day LIBOR with quarterly payments. Using the information in Table 1 and the formula below, what is the most appropriate swap fixed rate for this swap? where

Answer Choices:

A. 5.75%

B. 5.65%

C. 6.01%. C= 1 −Z4 Z1 + Z2 + Z3 + Z4 Zn = price of n − zero − coupon bond per $ of principal 1 1 + RN

Explanation

C= 1 −Z4 Z1 + Z2 + Z3 + Z4 Zn = price of n − zero − coupon bond per $ of principal 1 1 + RN The swap fixed rate is computed as follows: The fixed rate on the swap in annual terms is: 1.437% × 360 / 90 = 5.75%

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