Q2) Suppose the current one-year euro swap rate y0[0, 1] is 1.74%, and the two-yearand three-year swap rates are 2.24% and 2.55% respectively. Euro swap rates are quotedwith annual payments and 30/360 daycount (thus α = 1). A hedge fund(HF) executes the following two trades with a dealer:1(1) The HF pays fixed and receives floating on e100 million notional of a one-year swap atthe forward swap rate.(2) The HF receives fixed and pays floating on e100 million notional of a three-year swapat the forward swap rate.Assume bid-offer costs are negligible.a) After one year, what net cashflow has the dealer paid to (or received from) the HF?b) Suppose after one year, one-year and two-year euro swap rates are unchanged. What isthe current value of the remaining part of the HF trade?c) Suppose after one year, the one-year euro swap rate is unchanged but the two-year euroswap rate is now Y%. What value of Y gives a total zero profit on the trade (at T = 1)?d) Do you like the trades the HF executed? Discuss briefly the risks of the trade, inparticular commenting on which interest rates the HF is exposed to.
Q2) Suppose the current one-year euro swap rate y0[0, 1] is 1.74%, and the two-year
and three-year swap rates are 2.24% and 2.55% respectively. Euro swap rates are quoted
with annual payments and 30/360 daycount (thus α = 1).
A hedge fund
(HF) executes the following two trades with a dealer:
1
(1) The HF pays fixed and receives floating on e100 million notional of a one-year swap at
the forward swap rate.
(2) The HF receives fixed and pays floating on e100 million notional of a three-year swap
at the forward swap rate.
Assume bid-offer costs are negligible.
a) After one year, what net cashflow has the dealer paid to (or received from) the HF?
b) Suppose after one year, one-year and two-year euro swap rates are unchanged. What is
the current value of the remaining part of the HF trade?
c) Suppose after one year, the one-year euro swap rate is unchanged but the two-year euro
swap rate is now Y%. What value of Y gives a total zero profit on the trade (at T = 1)?
d) Do you like the trades the HF executed? Discuss briefly the risks of the trade, in
particular commenting on which interest rates the HF is exposed to.
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 2 images
