On June 12, 2020, the term structure of risk-free interest rate in Canada indicates that the annual- ized continuously compounding 1-year risk free rate is 0.90%, the 2-year rate is 1%, and the 3-year rate is 1.1%. Suppose you have a mortgage for which you have to pay annually a mortgage rate that is linked to the LIBOR variable rate. You are concerned that interest rate will rise over the course of the next three years.

a. Describewhatswap contracts you would use andhowto protect yourself against interest rate uncertainty. You may draw a diagram to indicate the cash inflow and outflow under your original mortgage and the swap contract.

b.] You goal is to calculate the fair swap rate under this 3-year swap. (1) Clearly identify what inputs would you need to arrive at your conclusion (2) Clearly identify what pricing princi- ple/steps would you use with all the inputs from (1) to arrive at your conclusion. (no numerical results, but please use accurate terminology)

c. After entering the swap contract, what risks will you be exposed to? What risks will the swap dealer be exposed to?

d. Describehowthe dealer can hedge her/his position in thewhatswap contract