OPTIONS AND DERIVATIVES

1.Suppose that the term structure is described in the following table:

maturity yield

6-month 2.5%

12-month 2.75%

18-month 3.0%

24-month 3.5%

Assume that 6-month LIBOR rate is 2.5%.

What is the market fixed rate (annualized, semiannual compounded) for a 2- year fixed-floating swap with semiannual payments?

XYZ entered into such a swap as the floating-rate payer, with a notional amount of $10 million. Two months later, suppose that the yield curve becomes flat at 2.5% for all maturities and the 6-month LIBOR rate is 2.5%. What is the value of the swap to XYZ?

If the counterpart defaults now, what is the loss to XYZ?