The manager of a $100 million portfolio, consisting of 10-year bonds that currently pay a coupon rate of 5%, believes that interest rates are about to rise. A dealer offers to swap the bonds cash flows, which are based on a fixed rate of 5%, for cash flows based on the LIBOR. Assume a notional principal of $100 million and that the swap will be for a one year period.

1.Briefly explain whether the portfolio manager should enter the swap agreement.

2.Assuming the swap is accepted, what is the income of the bond portfolio if the LIBOR rate increases to 6% in one years time?

3.What would the cash flow be from the swap conducted in question 2 above?

4.what would be the total income for the portfolio manager from the bonds plus the swap agreement?