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5. An investor enters a two-year total return swap to take on the risk in the 3-year bond X which is currently selling at par
5. An investor enters a two-year total return swap to take on the risk in the 3-year bond X which is currently selling at par with yield 12%. The face value of the bond is $10 million. During the two years, the investor pays the 1-year Libor rate plus 150 basis points every year in exchange for the total return on the bond X which makes the coupon payment annually. Now, suppose the 1-year Libor rates for year 1 and year 2 are 7.5% and 8%. At the end of two years, the yield on bond X decreases to 10%. What are the net cash flows for the investor in year 1 and in year 2
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