4.

1. (a) Explain the features of an interest rate swap, illustrating your answer with a simple numerical example. What benefits could a firm obtain from using interest rate swaps? (150 words) (8 marks)

2. (b) Why must the price of an American call option on a stock that pays no dividends always be higher than its intrinsic value? How can the price of an American call option be determined from the price of a European call option on the same stock with the same time to expiry? Explain. (180 words) (9 marks)

3. (c) Is it ever optimal to exercise an American put option before its expiration date, assuming the underlying stock pays no dividends? Explain your answer with reference to the put-call parity relationship. (150 words) (8 marks)

   (Total = 25 marks)