Two questions on FRA/Swaps (possible conflicting answers) conflict, equivalent, possible, following, principal

dmrktrading

Do the answers below conflict? Q1 says that payments will be determined at t = 0 and made at t = 6 months. Q2 says that payments will be determined at t = 6 months and made at t = 12 months.





Which of the following is equivalent to a pay-fixed swap with a tenor of two years with semi-annual swap payments and a fixed rate of 6% (exchanged for LIBOR)? The notional principal is $100,000,000.

A) A strip of three forward rate agreements, which obligates the party to pay a fixed rate of 6% and receive six-month LIBOR on a notional principal of $100,000,000.

B) A forward rate agreement, which obligates the party to pay a fixed rate of 6% and receive six-month LIBOR on a notional principal of $100,000,000.

C) A strip of two forward rate agreements, which obligates the party to pay a fixed rate of 6% and receive six-month LIBOR on a notional principal of $100,000,000.


The correct answer was A.

In an interest rate swap, the first payment is known with certainty and will be made at month 6. The determination dates for the floating rate will be at months 6, 12, and 18 and the corresponding payment dates will be at months 12, 18, and 24. These correspond to the three forward rate agreements.


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Which of the following is equivalent to a receive-fixed swap with a tenor of one and a half years with semi-annual swap payments and a fixed rate of 5% (exchanged for London Interbank Offered Rate (LIBOR))? Assume that the notional principal is $10,000,000.

A) A forward rate agreement, which obligates the party to receive a fixed rate of 5% and pay six-month LIBOR on a notional principal of $10,000,000.

B) A strip of three forward rate agreements, which obligates the party to receive a fixed rate of 5% and pay six-month LIBOR on a notional principal of $10,000,000.

C) A strip of two forward rate agreements, which obligates the party to receive a fixed rate of 5% and pay six-month LIBOR on a notional principal of $10,000,000.


Your answer: C was correct!

This is an example of two 6-month forward rate agreements (FRAs). The first FRA is entered into at time 0 with the payment determined at 6 months and paid at 12 months. The second FRA is entered into at 6 months with the payment determined at 12 months and paid at 18 months.

luda002

Right, but the 2-year semiannual fixed-pay swap should have 4 settlement dates and payments, so how is it equivalent to only 3 FRAs??

busterbluth

So if I understand correctly, the equivalent series of interest rate options would be 3 long calls and 3 short puts with strike rates of 6% that expires in 6, 12, and 18 months, so that they pay in months 12, 18, and 24 as well?

smuggycfa

Sorry guys, but I still dun think I quite follow here. For the 2-year semiannual fixed-pay swap in the example Q1 above, I thot there would be 4 payments in months 6, 12, 18, 24...

Can someone walk me thru the differences (similarities) of the settlement/payment dates for the swap and FRA? How many payments are there for each and when are the settlement, payment determination, and payment dates?

Thanks a mil!

giorgio10

1. Both of these questions are on SWAPS.
In Swaps => Always rate is known in advance - and pays in arrears.
the first payment is always known IN ADVANCE. You know the current month 6 month LIBOR, based on your contract you know the fixed rate.
SO you know who pays who - but this payment is always in arrears.

CP

giants2010

cpk:

i undersstand. payments are known in advance and paid later. but in the first question, it says payment is known at t = 0 and paid at t = 6. in the second, it says it is enteres at 0, determined at 6, and paid at 12.

isnt there a conflict there?

onelife1

"the first payment is known with certainty and will be made at month 6" is referring to the SWAP whereas "is entered into at time 0 with the payment determined at 6 months and paid at 12 months." is referring to the FRA.

The second answer explanation is worded poorly, implicit is the fact that the first payment on the swap is known.

bbtomato

1st q asks: equivalent to a pay-fixed i.e. receive floating
2nd q asks: equivalent to a receive-fixed, i.e pay-floating


1st answer : The determination dates for the floating rate will be at months 6, 12, and 18
2nd answer: The first FRA is entered into at time 0 with the payment determined at 6 months .

I don't see a difference ( or problem ) . The FRA is a forward agreement on swaps to be priced 6,12 months hence and paid 12,18 months later in both questions ( 1st one has one more 6 month tenor). Both cases identical for 1st two payments , determination and payment terms .

The FRA is a contract without a preset price , just an obligation to price and pay at the current rate 6 months later