QUESTION 4 An investor has purchased a floating-rate security with a 5-year maturity. The coupon formula for the floater is 6-month LIBOR plus 30 basis points and the interest payments are made semi-annually. The floater is not callable. At the time of purchase, 6-month LIBOR is 100 basis points. The investor borrowed the funds to purchase the floater by issuing a 5-year note at par value with a fixed coupon rate of 50 basis points. a) Ignoring credit risk, what is the risk that this investor faces? [5 marks] b) Suppose that the investor can enter into a 5-year interest rate swap with a third-party in which the investor pays LIBOR and receives 80 basis points and the frequency of the payments is semi-annual. What annual income spread (Le, net effect of all these transactions) can the investor lock in? [10 marks] c) Considering solely the level of interest rates now and that expected over the next 5 years, is it advisable for the investor to enter into the interest rate swap? Justify. [10 marks]