Financial Market

Swap Valuation. The date is January 3, 2012 and you just returned to work from a 80 thorough and exhausting celebration of the New Year. As a junior clerk on the USD fixedincome derivative desk your first transaction of the year involves a 5Y fixed-for-floating swap with yearly payments on $100m notional. Bloomberg provides you with the following data:

Payment Dates T-Strip Prices

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(Years) P (0, T)

1.0 95.39

2.0 90.63

3.0 85.78

4.0 80.93

5.0 76.11

(a) In terms of cash-replication, the above 5Y plain vanilla swap corresponds to holding what positions in what type of instruments?

(b) Calculate the 5Y swap rate for an annual fixed-for-floating USD swap. What is an appropriate bid-ask spread assuming that the Bloomberg data are midpoints?

(c) You ponder various strategies to hedge the resulting interest-rate exposure. Describe two different strategies which you could use to hedge the transaction.

(d) Your company has sold a 6Y plain-vanilla swap on 1Y LIBOR precisely one year ago for a swap rate of 7.15%; as a consequence, you receive fixed and pay floating. What value should your accounting system attribute to the swap today (notional principal: $40m)?