Question 2

a) When doing research, the analyst observed the one-year zero-coupon bond rate to be 2.6%, while the two-year zero-coupon bond rate was at 2.9%.

i. You have been tasked to calculate the rate on a 12x24 forward rate agreement (FRA) (12x24 means that the settlement is a year from now for delivery of the 1- year LIBOR at that date). (10 marks)

ii. In a scenario where the financial institution sold the above 12x24 FRA on $100 million notional principal, what would be the relevant transactions at the settlement date (which is one year from the date of purchase of the FRA)?

Assume one-year LIBOR turns out to be 2% at settlement date.

Using your same answer in (i), determine both the direction and amount of the settlement cashflows. Explain your answers. (20 marks)

b) Assuming the current 6-month LIBOR rate is 3.60% and the 9-month LIBOR rate is 3.75%, derive the rate on a 6x9 FRA.

In your derivation, use a day count of 182 for the 6-month period and of 91 for the threemonth period after that. There will be 364 days for the 12 months. (10 marks)

c) Assuming the current 3-month LIBOR rate is 2.2% and the 12-month LIBOR rate is 2.5%, derive the rate on a 3x12 FRA.

In your derivation, use a day count of 91 for the 3-month period and 364 days for the 12 months.