3. Show how you would engineer the following Snowball Note. Issuer: ABC bank Notional: $10 mio Tenor: 10 years; Principal: Guaranteed at maturity Coupon: Yr 1; Q1: 9.00% Q2: Previous Coupon + CMS10 4.65% Q3: Previous Coupon + CMS10 4.85% Q4: Previous Coupon + CMS10 5.25% Yr 2 Q1: Previous Coupon + CMS10 5.45% Yr 2 Q2-Q4: Previous Coupon + CMS10 5.65% Yr 3: Previous Coupon + CMS10 5.75% Yr 4-10: Previous Coupon Coupon subject to a minimum of 0% Call: Callable on each coupon

(a) What is the view of the investor?

(b) What are the risks?

(c) Now forget about the call provision and calculate the coupons paid under the two following realizations of Libor rates: Realization 1 = 5.0, 6.0, 6.5, 7.0, 8.0, 9.0, 10.0 Realization 2 = Libor stays at 3.5

(d) How can you characterize these coupons using a swap? What type of swap is this?

(e) Suppose you have 8 annual FRAs quoted to you. How can you price these coupon payments?

(f) How do you generate the first year coupon? (g) Are the coupons floored at 0? (h) Write a contractual equation representing this instrument.