swap question question

torontoanalyst

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.

chaojimali

C
2 not 3

SeanWest

C

NO EXCUSES

Otabek

bpdulog Wrote:
-------------------------------------------------------
> C


What is the rationale behind it being C?

Sportsman

Schweser question. C is correct - 2 strips of FRA

I can never understand the answer though.

enter into one FRA strip now. payment determined in 6 months and made in 12 months?
enter into the next FRA in 6 months, payment determined at 1 year and then made 1.5 years?

Where is the payment at 6 months though? the swap will pay in 6 months, but the FRA wont..???

cv4cfa

swap paying in 6 months is based on current LIBOR - so it is known in advance.... (when you enter into the swap). You price the fixed side, you know today's LIBOR - so you know what payment is due in 6 months time (remember the PAY IN ARREARS part)

CP

luda002

actually the answer depends if the LIBOR for the first interest period is already fixed or not.

If not, I say close 3 FRAs (0x6 first one, the question is if anyone would quote it)

We could also argue that there is no information when the swap starts, ...

but obviously the answer is C,

the cash flows will not match, the value will not match,

they have equivalent interest rate risk (more or less)

BelalM

^^^ CPK - I understand where the 6 month payment on the SWAP comes from, but how is the equivalent an FRA.

Won't a 6 month LIBOR FRA payment be determined in 6 months, but not made until 1 year??

Houjichasan

actually FRA 6x12 will be determined and settled in 6M (the interest difference will be discounted) the cash flows will not match

see my post above for the rest

ppls

^^ thanks!

FRAs and swaps kill me.