Chapter5 INTEREST RATE PART 1 SPOT AND FORWARD

Chapter#5 INTEREST RATE (PART 1): SPOT AND FORWARD RATES SWAPS Salma Alsuwail

✘ Spot Rate, �� t The annualized yield rate for a zero-coupon bond that matures in t years. Spot rates measure the yield from the beginning of the investment to the end of the single cash flow. The yield is written as an annual effective yield. 2 Salma Alsuwail

✘ Forward rate, �� [t 1, t 2] An annualized interest rate that will be earned from time t 1 to time t 2. t m t+m (1+ �� t). (1+�� [t, t+m]) = (1+ �� t+m) t (1+ �� t) = (1+�� [0, 1]). (1+�� [1, 2]) ……… (1+�� [t-1, t]) Salma Alsuwail

✘ Interest Rate Swap An interest rate swap is an agreement between two parties in which both parties agree to exchange a series of cash flows based on interest rates. The party who agrees to pay the fixed rate is called the payer. The counterparty who agrees to receive the fixed rate is called the receiver. Since there are only two parties in a swap, the party who pays the fixed rate must also be the party who receives the variable rate. The party who receives the fixed rate must also be the party who pays the variable rate. The fixed rate is called the swap rate. The variable rate is also known as the floating rate. If notional amount is not level: If notional amount is level: 4 Salma Alsuwail

examples ✘ You are given the following term structure of spot interest rates: A three-year annuity-immediate will be issued a year from now with annual payments of 5, 000. calculate the present value of this annuity a year from now. A 13, 296 B 13, 153 C 13, 401 D 13, 321 E 13, 094 Salma Alsuwail

✘ A company plans to invest X at the beginning of each month in a zero-coupon bond in order to accumulate 100, 000 at the end of six months. The price of each bond as a percentage of redemption value is given in the following chart: Calculate X given that the bond prices will not change during the six-month period. A 15, 667 B 16, 078 C 16, 245 D 16, 667 E 17, 271 Salma Alsuwail

✘ You are given the following swap rates for t-year interest rate swap: Calculate the price of a three-year zero-coupon bond with a maturity of 1. A 0. 28 B 0. 8536 C 0. 8540 D 0. 95 E 1. 00 Salma Alsuwail

✘ Zero-coupon bond prices per $1 of maturity payment are as follows: Calculate the fixed rate in a 3 -year interest rate swap. A 3. 4% B 3. 7% C 4. 0% D 4. 2% E 4. 4% Salma Alsuwail

THANKS! Any questions? 9 Salma Alsuwail