As a pension fund manager, you anticipate that you have to pay out 8 percent on $100 million for the next five years. The payment is made semi-annually. You currently hold $100 million of floating-rate note that pays LIBOR + 0.5 percent.  What is your potential risk?

To reduce your risk, you arrange a swap with a dealer who agree to pay you 7.55 percent fixed rate, while you pay him LIBOR. The swap payment is made semi-annually as well. Determine if you have sufficient cash flow to pension fund holder. Justify your answer.

 

A hedge fund is currently engaged in a plain vanilla interest rate swap with a company named BlueTrade. Under the terms of the swap, the hedge fund receives six-month LIBOR and pay 5 percent per annum on a principle of $100 million for five years. Payments are made every 6 months at rear.  Assume that the interest rates start to soar after two years and BlueTrade defaults on the seventh payment date when the LIBOR rate is 8 percent for all maturities (with semi-annual compounding). The 6-months LIBOR rate 6-months ago is 7.5 percent. 

What is the loss to the hedge fund?

Answer rating: 100% (QA)

For the first question the potential risk is the uncertainty of future interest rates and how they will impact the cash flows of the pension fund Spec... View the full answer