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Swaps Question - 722.2

Eustice_Langham

Active Member
Hi David, I have a question re the headed question. I have copied the answer below but I have the following questions re the solution:

"We can value this swap as two bonds (see upper panel below). Although it might be easier to recognize that the exchange in three months will be zero, such that only the cash flow at nine months needs to be evaluated: The floating rate pays 0.5 * $400 million * 2*[exp(0.0220/2)-1] = $4.42429 million and the fixed rate pays $6.00; so the future (and final) net cash flow exchange is $1.57571, which has a present value of $1.54993 million."

My questions are as follows:

1. Why does only the 9 months CF need to be evaluated? I would have thought that the 3 months CF should be evaluated as well.

2. Why is the fixed rate of only $6.00, this is only the interest cost, if a final payment should the amount be $406m? I have calculated the final fixed payment as follows: 406m/(1+.02)^.75]

3. I notice that your solution also contains discount factors, how were they calculated and finally, the PV amount of 1.54993, can you clarify how this was arrived at?

Thanks
 

Nicole Seaman

Director of FRM Operations
Staff member
Subscriber
Hi David, I have a question re the headed question. I have copied the answer below but I have the following questions re the solution:

"We can value this swap as two bonds (see upper panel below). Although it might be easier to recognize that the exchange in three months will be zero, such that only the cash flow at nine months needs to be evaluated: The floating rate pays 0.5 * $400 million * 2*[exp(0.0220/2)-1] = $4.42429 million and the fixed rate pays $6.00; so the future (and final) net cash flow exchange is $1.57571, which has a present value of $1.54993 million."

My questions are as follows:

1. Why does only the 9 months CF need to be evaluated? I would have thought that the 3 months CF should be evaluated as well.

2. Why is the fixed rate of only $6.00, this is only the interest cost, if a final payment should the amount be $406m? I have calculated the final fixed payment as follows: 406m/(1+.02)^.75]

3. I notice that your solution also contains discount factors, how were they calculated and finally, the PV amount of 1.54993, can you clarify how this was arrived at?

Thanks
Hello @Eustice_Langham

This is one of our paid practice questions for those who have paid for an FRM study package. David has discussed this practice question extensively in the paid section of the forum here: https://www.bionicturtle.com/forum/...and-basic-interest-rate-swap-valuation.10657/. If you would like access to the paid section of the forum, you would need to purchase one of our study packages. I was not able to find a previous order from you (maybe you purchased under a different username). I was going to look up your account to see when you purchased so I could provide you with information on an extension, but I cannot find an order from you.
 

Eustice_Langham

Active Member
Nicole, you are correct in that I dont have a paid subscription this question ie 722.2 is a question that I downloaded from your website as its a sample question, that BT provide for free. I can send through the actual document if you would like to see this. If however its still not something that you can discuss then I understand. Thankyou
 
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