Company X and Company Y have been offered the following quarterly compounded rates per annum on a 5-year investment with a principal of $10x: X2 = 3 Company Fixed rate (%) Floating rate (basis points over LIBOR) X3 = 9 XE = 7 X x + x x, + max(x3,x) 10(x2 + x3) 10x, max(X5, X) Y X6 = 0 (a) Company X and Company Y wish to use swap to transform their investment incomes from their respective apparent comparative-advantage interest rates market. Design a swap that will net a bank who acts as an intermediary, at 0.05% per annum and that will appear equally attractive to the companies. (9 marks) (b) Under the terms of the swap, Company X and Company Y are going to pay and receive payments from the bank 4 times in a year. The 3-month LIBOR rate was 6.0% per annum on the previous payment date. The average of the bid-offer rate being exchanged for 3- month LIBOR in swaps for all maturities is currently x% per annum with continuous compounding. Ignoring day count issues, determine the current value of the swap and the possibility of credit risk associated with the swap to Company X and Company Y if the interest rate swap still has x months left from today, including today's transactions, if any. Use bond valuation approach for Company X and forward rate agreement (FRA) approach for Company Y. (14 marks) Company X and Company Y have been offered the following quarterly compounded rates per annum on a 5-year investment with a principal of $10x: X2 = 3 Company Fixed rate (%) Floating rate (basis points over LIBOR) X3 = 9 XE = 7 X x + x x, + max(x3,x) 10(x2 + x3) 10x, max(X5, X) Y X6 = 0 (a) Company X and Company Y wish to use swap to transform their investment incomes from their respective apparent comparative-advantage interest rates market. Design a swap that will net a bank who acts as an intermediary, at 0.05% per annum and that will appear equally attractive to the companies. (9 marks) (b) Under the terms of the swap, Company X and Company Y are going to pay and receive payments from the bank 4 times in a year. The 3-month LIBOR rate was 6.0% per annum on the previous payment date. The average of the bid-offer rate being exchanged for 3- month LIBOR in swaps for all maturities is currently x% per annum with continuous compounding. Ignoring day count issues, determine the current value of the swap and the possibility of credit risk associated with the swap to Company X and Company Y if the interest rate swap still has x months left from today, including today's transactions, if any. Use bond valuation approach for Company X and forward rate agreement (FRA) approach for Company Y. (14 marks)
