A financial institution trades swaps where 12 month LIBOR is exchanged for a fixed rate of interest. Payments are made once a year. The one-year swap rate (i.e., the rate that would be exchanged for 12 month LIBOR in a new one-year swap) is 6 percent. Similarly the two-year swap rate is 6.5 percent.

a) Use this swap data to calculate the one and two year LIBOR zero rates, expressing the rates with continuous compounding.

b) What is the value of an existing swap with a notional principal of $10 million that has two years to go and is such that financial institution pays 7 percent and receives 12 month LIBOR? Payments are made once a year.

c) What is the value of a forward rate agreement where a rate of 8 percent will be received on a principal of $1 million for the period between one year and two years?