7. What is the value of the interest rate swap on April 5, 2016 if we use LIBOR as a proxy for the risk free rate? What if we use OIS rates as a proxy for the risk free rate? Which one is more suitable? For the calculations make the following assumptions. Use the rates in Exhibits 4 to 6. Use linear interpolation in Exhibit 4 to obtain a proxy for the 9- month LIBOR. Assume that there are exactly 9 months left to maturity and the next swap payment is in exactly 3 months. For simplicity ignore day count conventions and note that the listed LIBOR and OIS rates are quoted with a compounding frequency that corresponds to the term (i.e., the N-month rate is compounded once within N months, or 12/N times per annum). EXHIBIT 4: LIBOR RATES* (as of April 5, 2016) Libor Rates (%) Overnight 1 Week 1 Month 2 Month 3 Month 6 Month 1 Year USD 0.3794 0.396 0.4402 0.5225 0.6301 0.9041 1.2215 Euro -0.39043 -0.37429 -0.33214 -0.27929 -0.25114 -0.136 -0.01529 Pound 0.4825 0.48719 0.50881 0.55 0.5875 0.74013 1.00213 YEN -0.08971 -0.07686 -0.06571 -0.01014 -0.00457 0.02264 0.10286 * LIBOR rates are quoted with a compounding frequency that corresponds to the term. For example, the spot LIBOR three- month rate would earn an interest rate equivalent to 0.25 * 0.6301 per cent every three months. For the spot LIBOR six-month rate, the corresponding interest rate equivalent would be 0.5 * 0.9041 per cent semi-annually. Source: Case authors using data from "Market Data Center," The Wall Street Journal, accessed April 5, 2016, http://online.wsj.com/mdc/public/page/2_3020-libor.html. EXHIBIT 5: FEDERAL FUNDS RATE (As of April 5, 2016) Effective rate Target rate High Low Bid Offer 0.38 0.25-0.50 0.5625 0.30 0.37 0.50 Source: Case authors using data from "Money Rates," The Wall Street Journal, accessed April 5, 2016 http://online.wsj.com/mdc/public/page/2_3020-moneyrate.html. EXHIBIT 6: USD OVERNIGHT INDEX SWAPS-SETTLEMENTS (as of April 5, 2016) Term 1 Week 2 Week 3 Week 1 Month 2 Month 3 Month | 4 Month 5 Month 6 Month 9 Month 06:00 EDT 0.36000 0.36000 0.36100 0.36200 0.36600 0.37950 0.39200 0.40200 0.41400 0.44550 Source: Case authors using data from Bloomberg, accessed April 5, 2016. 7. What is the value of the interest rate swap on April 5, 2016 if we use LIBOR as a proxy for the risk free rate? What if we use OIS rates as a proxy for the risk free rate? Which one is more suitable? For the calculations make the following assumptions. Use the rates in Exhibits 4 to 6. Use linear interpolation in Exhibit 4 to obtain a proxy for the 9- month LIBOR. Assume that there are exactly 9 months left to maturity and the next swap payment is in exactly 3 months. For simplicity ignore day count conventions and note that the listed LIBOR and OIS rates are quoted with a compounding frequency that corresponds to the term (i.e., the N-month rate is compounded once within N months, or 12/N times per annum). EXHIBIT 4: LIBOR RATES* (as of April 5, 2016) Libor Rates (%) Overnight 1 Week 1 Month 2 Month 3 Month 6 Month 1 Year USD 0.3794 0.396 0.4402 0.5225 0.6301 0.9041 1.2215 Euro -0.39043 -0.37429 -0.33214 -0.27929 -0.25114 -0.136 -0.01529 Pound 0.4825 0.48719 0.50881 0.55 0.5875 0.74013 1.00213 YEN -0.08971 -0.07686 -0.06571 -0.01014 -0.00457 0.02264 0.10286 * LIBOR rates are quoted with a compounding frequency that corresponds to the term. For example, the spot LIBOR three- month rate would earn an interest rate equivalent to 0.25 * 0.6301 per cent every three months. For the spot LIBOR six-month rate, the corresponding interest rate equivalent would be 0.5 * 0.9041 per cent semi-annually. Source: Case authors using data from "Market Data Center," The Wall Street Journal, accessed April 5, 2016, http://online.wsj.com/mdc/public/page/2_3020-libor.html. EXHIBIT 5: FEDERAL FUNDS RATE (As of April 5, 2016) Effective rate Target rate High Low Bid Offer 0.38 0.25-0.50 0.5625 0.30 0.37 0.50 Source: Case authors using data from "Money Rates," The Wall Street Journal, accessed April 5, 2016 http://online.wsj.com/mdc/public/page/2_3020-moneyrate.html. EXHIBIT 6: USD OVERNIGHT INDEX SWAPS-SETTLEMENTS (as of April 5, 2016) Term 1 Week 2 Week 3 Week 1 Month 2 Month 3 Month | 4 Month 5 Month 6 Month 9 Month 06:00 EDT 0.36000 0.36000 0.36100 0.36200 0.36600 0.37950 0.39200 0.40200 0.41400 0.44550 Source: Case authors using data from Bloomberg, accessed April 5, 2016