Question
Assume oil forward prices for 1 year, 2 years, and 3 years are 20, 21, and 22. The 1-year effective annual interest rate is 6%,
Assume oil forward prices for 1 year, 2 years, and 3 years are 20, 21, and 22. The 1-year effective annual interest rate is 6%, the two year rate is 6.5%, and the 3-year rate is 7%.
Suppose you are a dealer who is paying the fixed oil price and receiving the floating price. Suppose you enter into the swap and immediately thereafter all interest rates rise 50 basis points and oil forward prices are unchanged. What happen to your swap position? What if inter- est rate fall 50 basis points? What hedging instrument would have protected against interest risk in this position?
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