A company is engaged in a two-year swap with quarterly payments. It is paying 6% fixed and receiving Libor. It would like the flexibility to terminate the swap at any time prior to the end of the two-year period.

A. Identify the type of swaption that would achieve this objective.

B. Consider a time t during this two-year life of the swaption in which it is being considered for exercise. Use a 7% exercise rate. The fixed rate in the market on a swap that would offset the existing swap is denoted as FS(t,2). Examine the payoffs of the swaption based on whether FS(t,2) is 1) equal to or above 7% or 2) below 7%.