A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding) has a remaining life of nine months. The six-month LIBOR rate observed three months ago was 4.85% with semi-annual compounding
Today's three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respectively. From this it can be calculated that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-annual compounding. If the swap has a principal value of $15,000,000, what is closest to the value of the swap to the party receiving a fixed rate of interest?
A. $74,250
B. ?$70,760
C. ?$11,250
D. $103,790
B
The forward rates for the floating payment at time 9 months is 6.14%. The swap can be valued assuming that the fixed payments are 2.5% of principal at 3 months and 9 months and that the floating payments are 2.425% and 3.07% of the principal at 3 months and 9 months. The value of the swap to the party receiving fixed is therefore
15,000,000(0.025-0.02425)e-0.053×0.25+15,000,000(0.025-0.0307)e-0.058×0.75 = –$70,760
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