Suppose that we have the following zero-coupon yields. Maturity r 0.5 1 1.5 2 Annual interest...

Transcribed Image Text:

Suppose that we have the following zero-coupon yields. Maturity r 0.5 1 1.5 2 Annual interest rates that are semi-annually compounded 0.02 0.025 0.03 0.04 1. What is the fair fixed rate in a 2-year interest rate swap in which fixed and floating payments are exchanged every six months? Note that in the lecture slides, payments were either quarterly or annual. Here, they are semi-annual. 2. Treat the two sides of the interest rate swap as a fixed coupon bond and a floating coupon bond as we did in class (by adding the notional to the end of the contract). Calculate the modified durations of the fixed coupon and floating coupon bonds. 3. Suppose that half a year passes. The term structure of zero-coupon yields is now Maturity r 0.04 0.045 0.05 0.5 1 1.5 Annual interest rates that are semi-annually compounded If you entered into a fixed-for-floating contract previously (with a notional of $100), what is the value of your position now? Why did you make or lose money? (Think about this in terms of how sensitive each side of the interest rate swap is to a change in interest rates.) Suppose that we have the following zero-coupon yields. Maturity r 0.5 1 1.5 2 Annual interest rates that are semi-annually compounded 0.02 0.025 0.03 0.04 1. What is the fair fixed rate in a 2-year interest rate swap in which fixed and floating payments are exchanged every six months? Note that in the lecture slides, payments were either quarterly or annual. Here, they are semi-annual. 2. Treat the two sides of the interest rate swap as a fixed coupon bond and a floating coupon bond as we did in class (by adding the notional to the end of the contract). Calculate the modified durations of the fixed coupon and floating coupon bonds. 3. Suppose that half a year passes. The term structure of zero-coupon yields is now Maturity r 0.04 0.045 0.05 0.5 1 1.5 Annual interest rates that are semi-annually compounded If you entered into a fixed-for-floating contract previously (with a notional of $100), what is the value of your position now? Why did you make or lose money? (Think about this in terms of how sensitive each side of the interest rate swap is to a change in interest rates.)

Answer rating: 100% (QA)

SOLUTION Zerocoupon yields are the yields of bonds with maturities equal to the time periods between the dates of issue and maturity They are used to ... View the full answer