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Use x1=1, x2 = 8, x3 = 1, x4 = 1, x5= 6, x6 = 2, x7 = 8, x8 = 5 to answer
Use x1=1, x2 = 8, x3 = 1, x4 = 1, x5= 6, x6 = 2, x7 = 8, x8 = 5 to answer the following questions. Company X and Y have been offered the following quarterly compounded rates per annum on a 10-year loan with a principal of $100x: Company X Y Fixed rate (%) Floating rate (basis points over LIBOR) x1 + x2 10(x1+x2) 1 + max(x, x6) 10xmax(x5, x6) (a) Company X and Company Y wish to use swaps to transform their loans from their respective apparent comparative-advantage interest rates market. Design a swap that will net a bank who acts as an intermediary at 0.05% per annum with quarterly compounding and appear equally attractive to the companies. (10 marks) (b) Under the terms of the swap, Company X and Company Y are going to pay and receive payments from the bank 4 times a year. The quarterly compounded 3-month LIBOR rate was 0.2% per annum on the previous payment date. The average of the bid-offer rate being exchanged for 3-month LIBOR in swaps for all maturities is currently 0.6% per annum with continuous compounding. Ignoring day count issues, determine the current value of the swap and the possibility of credit risk associated with the swap to Company X and Company Y if the interest rate swap still has E x months left from today, 8 i=1 including today's transactions, if any. Use the bond valuation approach for Company X and the forward rate agreement (FRA) approach for Company Y. (15 marks)
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