Question
Swap Valuation. You just returned to work from a thoroughly exhausting vacation in South 100+20 Beach, Miami, FL partying non stop. As a junior clerk
Swap Valuation. You just returned to work from a thoroughly exhausting vacation in South 100+20 Beach, Miami, FL partying non stop. As a junior clerk on the USD fixed-income derivative desk your first transaction involves a 7Y fixed-for-floating swap with yearly payments on $500m notional for a valued customer who just issued an equivalent amount of floating-rate 4 Eurodollar notes, which pay interest once a year. On March 17, 2022, Bloomberg provides you with the following data:
Payment Dates Spot Rates (%) 1.0 1.30, 2.0 1.94, 3.0 2.14, 4.0 2.16, 5.0 2.17, 6.0 2.20, 7.0 2.22 Strip Prices (years) rt P (0, T)
(a) What is the customer attempting to achieve?
(b) In terms of cash-flow replication, the above 7Y plain vanilla swap corresponds to holding what positions in what type of instruments?
(c) How much is the swap worth at inception?
(d) Calculate the 7Y swap rate for an annual fixed-for-floating USD swap. What is an appropriate bid-ask spread assuming that the Bloomberg data are midpoints?
(e) You ponder various strategies to hedge the resulting interest-rate exposure. Describe two different strategies which your could use to hedge the transaction.
(f) Your company has sold a 8Y plain-vanilla swap on 1Y SOFR precisely one 20 year ago for a swap rate of 0.76%; as a consequence, you receive fixed and pay floating. What value should your accounting system attribute to the swap today (notional principal: $140m)?
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