Question #55 - Reading 31 Valuation of Contingent Claims

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 25

Status: Unattempted

Correct Answer: A

Shared Context

- 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 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

Question

For this question only, assume Bower expects the currently positively sloped LIBOR curve to shift upward in a parallel manner. Using a plain vanilla interest rate swap, which of the following will allow Bower to best take advantage of his expectations? Purchase a:

Answer Choices:

A. pay fixed interest rate swap

B. floating rate bond and enter into a receive fixed swap

C. receive fixed interest rate swap

Explanation

Since the interest rates are expected to rise for all maturities, one can benefit from this rise by receiving a floating rate (LIBOR) and borrowing at a fixed rate (i.e. a pay fixed swap).

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