An interest rate swap has three years of remaining life. Payments are exchanged annually. Interest at 3% is paid and 12-month LIBOR is received. A exchange of payments has just taken place
The one-year, two-year and three-year LIBOR/swap zero rates are 2%, 3% and 4%. All rates an annually compounded. What is the value of the swap as a percentage of the principal when LIBOR discounting is used.
A. 0.00%
B. 2.66%
C. 2.06%
D. 1.06%
B
Suppose the principal 100 . The value of the floating rate bond underlying the swap is 100 . The value of the fixed rate bond is 3/1.02+3/(1.03)2+103/(1.04)3=97.34 . The value of the swap is therefore 100?97.34 = 2.66 or 2.66% of the principal
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