Question
Suppose the current one-year euro swap rate y0[0,1] is 1.74%, and the two-year and three-year swap rates are 2.24% and 2.55% respectively. Euro swap rates
Suppose the current one-year euro swap rate y0[0,1] is 1.74%, and the two-year and three-year swap rates are 2.24% and 2.55% respectively. Euro swap rates are quoted with annual payments and 30/360 daycount (thus = 1).
A hedge fund executes the following two trades with a dealer:
1) The hedge fund pays fixed and receives floating on 100 million notional of a one-year swap at the forward swap rate.
(2) The hedge fund receives fixed and pays floating on 100 million notional of a three-year swap at the forward swap rate. Assume bid-offer costs are negligible.
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a) After one year, what net cashflow has the dealer paid to (or received from) the HF?
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b) Suppose after one year, one-year and two-year euro swap rates are unchanged. What is the current value of the remaining part of the hedge fund trade?
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c) Suppose after one year, the one-year euro swap rate is unchanged but the two-year euro swap rate is now Y%. What value of Y gives a total zero profit on the trade (at T = 1)?
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d) Do you like the trades the hedge fund executed? Discuss briefly the risks of the trade, in particular commenting on which interest rates the hedge fund is exposed to.
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