Swaps often contain caps or floors In this problem, you are to construct an oil contract that has the following characteristics The initial cost is zero Then in each period, the buyer pays the market price of oil if it is between K 1 and K 2 otherwise, if S 1, the buyer pays K 1 , and if S K 2 , the buyer pays K 2 (there is a floor and a cap) Assume that K 2 K 1 $2 and that oil volatility is 15 a If there is a single settlement date in 1 year, what are K 1 and K 2 b If the swap settles quarterly for eight quarters, what are K 1 and K 2

Question: Swaps often contain caps or floors. In this problem, you are to construct an oil contract that has the following characteristics: The initial cost is

Swaps often contain caps or floors. In this problem, you are to construct an oil contract that has the following characteristics: The initial cost is zero. Then in each period, the buyer pays the market price of oil if it is between K₁ and K₂; otherwise, if S 1, the buyer pays K₁, and if S >K₂, the buyer pays K₂ (there is a floor and a cap). Assume that K₂ − K₁= $2 and that oil volatility is 15%.

a. If there is a single settlement date in 1 year, what are K₁ and K₂?

b. If the swap settles quarterly for eight quarters, what are K₁ and K₂?

Step by Step Solution

★★★★★

3.27 Rating (156 Votes )

There are 3 Steps involved in it

1 Expert Approved Answer

Step: 1 Unlock

The contract has the party receiving a K 2 call and writing a K 1 put We will assume K ... View full answer

Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock

Step: 3 Unlock

Document Format (1 attachment)

511-B-C-F-C-V (1070).docx

120 KBs Word File

Students Have Also Explored These Related Corporate Finance Questions!

You have been asked to construct an oil contract that has the following characteristics: The initial cost is zero. Then in each period, the buyer pays S F, with a cap of $21.90 F and a floor of...

In this problem you will compute January 12 2004 bid and ask volatilities (using the Black-Scholes implied volatility function) for 1-year IBM options expiring the following January. Note that IBM...

17. Swaps often contain caps or floors. In this problem, you are to construct an oil contract that has the following characteristics: The initial cost is zero. Then in each period, the buyer pays the...

Swaps often contain caps or floors. In this problem, you are to construct an oil contract that has the following characteristics: The initial cost is zero. Then in each period, the buyer pays the...

Evaluate the potential gains and losses for forwards,future,call options,put options and swaps. Outline and describe the different risks that each type of derivative contract faces. Describe...

Research Paper: Topic: Why did the traditional financial risk approaches, methods, and tools fail in the financial market meltdown of 2008 - 2009? Discuss questions DQ #1: How has fair value...

Companies can intentionally commoditize their products or services as a strategy to make money. Discuss using these two different cases below how companies can intentionally commoditize their...

Hi Katrina, I have another accounting problem I need your help with. It's similar to the one you did on 4/4/2016. The due date for this one will be 4/10/2016, Will you be able to help? See below...

Two types of barrel units were in use in the I920s in the United States. The apple barrel had a legally set volume of 7056 cubic inches; the cranberry barrel, 5826 cubic inches. If a merchant sells...

Consider the closed-loop second-order system y = [2 0]x + [0]µ. Compute the sensitivity of the closed-loop system to variations in the parameter K. 0 3 5

Which of the following statements is CORRECT, other things held constant? Interest rates on long term binds are more volatile than rates in short - term debt securities like t - bills. Interest rates...

7.1 Review and define each of the chapter's key terms.

5. Suppose you observe the following continuously compounded zero-coupon bond yields: 0.06766 (1-year), 0.05827 (2-year), 0.04879 (3-year), 0.04402 (4-year), 0.03922 (5-year). For each maturity year...

6. Suppose you observe the following par coupon bond yields: 0.03000 (1-year), 0.03491 (2-year), 0.03974 (3-year), 0.04629 (4-year), 0.05174 (5-year). For each maturity year compute the zero-coupon...

7. Using the information in Table 1, a. Compute the implied forward rate from time 1 to time 3. b. Compute the implied forward price of a par 2-year coupon bond that will be issued at time 1.

Consider the following code segment. Assume that index 1 is a number between 1 and LENGTH ( theList ) , inclusive, and index 2 is a number between 2 and LENGTH ( theList ) - 1 , inclusive.

A 9-year annuity of 18 $9,900 semiannual payments will begin 11 years from now, with the first payment coming 11.5 years from now. Requirement 1: If the discount rate is 8 percent compounded...

Which of the following must be considered before assessing the skills of equity fund managers? a. The average dividend payout ratios b. The P/E ratios of key market sectors c. The industry sectors...