1. Suppose that oil forward prices for 1 year, 2 years and 3 years are $40, $42, and $43. The 1-year effective annual interest rate is 5%, the 2-year rate 6% and the 3-year rate 6.5%

a.What is the 3-year swap price?

b.Suppose that, instead of being at-market, the swap in (a) requires the long to make a payment of $50 when the swap is initiated in addition to a swap price every year when the

oil is delivered. What is the 3-year swap price under this arrangement?

c.What is the price of a 2-year at -market swap beginning in one year? (That is, the first swap settlement is will be in 2 years; the second and last settlement in 3 years. No money changes hands with the contract is initiated.)

d. Suppose a dealer pays the fixed price and receives floating under the swap agreement described in (b). What position in oil forward contracts will hedge oil price risk in this position? Verify that the present value of the locked-in net cash flows is zero.