1). A firm has entered into a 4-year, annual-pay, 6% plain vanilla interest rate swap with a notional principal value of $10,000,000. The firm is the fixed rate payer (i.e. the swap dealer is the floating rate payer) and the following spot rates are observed and expected over the next three years:

• 1-year LIBOR today = 5%.

• Expected 1-year LIBOR in a year = 6%.

•Expected 1-year LIBOR in two years = 7%.

Based solely on this information, what would be (A) the first net payment amount and (B) the direction (e.g. from the firm to the swap dealer or vice versa)?

2). Consider an option expiring in 90 days on 180-day LIBOR. The option buyer chooses an exercise rate of 5.5% and a notional principal of $10 million. On the expiration day, 180- day LIBOR is 6%.

Is this option in-the-money or out-of-the-money?

What is the payoff to the holder of the option