The Kingdom of Papou issues a very-bull bond with a coupon equal to:
14.6 - 2 * LIBOR.
Of course, the coupon cannot be negative.
The Kingdom could have issued a FRN at LIBOR + ¼%, or a straight bond at 5.30%.
The current market conditions for swaps are 5% against LIBOR.
You could also trade in CAPS and FLOORS with different exercise prices (these are levels of interest rates). The premiums are paid annually.
a. You are a buyer of this very-bull bond. Tell us what it is equivalent to, in terms of buying/selling: FRN, straight bonds, caps or floors?
b. Assume that the Kingdom actually wanted to issue a straight bond (fixed coupon). The bank will put in place a "de-mining" portfolio with swaps and options so that this very-bull bond plus the "de-mining" portfolio is equivalent to a straight bond. What is exactly the "de-mining" portfolio? [Be very precise and tell us if the Kingdom must pay fixed, receive LIBOR or vice versa, etc. ...]
c. What is the cost advantage for the Kingdom compared to issuing bonds @ 5.30 %?
d. Same question assuming that the Kingdom wanted to issue an FRN @LIBOR + ¼ %?

Question

The Kingdom of Papou issues a very-bull bond with a coupon equal to:
14.6 - 2 * LIBOR.
Of course, the coupon cannot be negative.
The Kingdom could have issued a FRN at LIBOR + ¼%, or a straight bond at 5.30%.
The current market conditions for swaps are 5% against LIBOR.
You could also trade in CAPS and FLOORS with different exercise prices (these are levels of interest rates). The premiums are paid annually.
  a. You are a buyer of this very-bull bond. Tell us what it is equivalent to, in terms of buying/selling: FRN, straight bonds, caps or floors?
b. Assume that the Kingdom actually wanted to issue a straight bond (fixed coupon). The bank will put in place a "de-mining" portfolio with swaps and options so that this very-bull bond plus the "de-mining" portfolio is equivalent to a straight bond. What is exactly the "de-mining" portfolio? [Be very precise and tell us if the Kingdom must pay fixed, receive LIBOR or vice versa, etc. ...]
c. What is the cost advantage for the Kingdom compared to issuing bonds @ 5.30 %?
d. Same question assuming that the Kingdom wanted to issue an FRN @LIBOR + ¼ %?

Quizplus · Accepted Answer

The Answer of The Kingdom of Papou issues a very-bull bond with a coupon equal to:
14.6 - 2 * LIBOR.
Of course, the coupon cannot be negative.
The Kingdom could have issued a FRN at LIBOR + ¼%, or a straight bond at 5.30%.
The current market conditions for swaps are 5% against LIBOR.
You could also trade in CAPS and FLOORS with different exercise prices (these are levels of interest rates). The premiums are paid annually.
  a. You are a buyer of this very-bull bond. Tell us what it is equivalent to, in terms of buying/selling: FRN, straight bonds, caps or floors?
b. Assume that the Kingdom actually wanted to issue a straight bond (fixed coupon). The bank will put in place a "de-mining" portfolio with swaps and options so that this very-bull bond plus the "de-mining" portfolio is equivalent to a straight bond. What is exactly the "de-mining" portfolio? [Be very precise and tell us if the Kingdom must pay fixed, receive LIBOR or vice versa, etc. ...]
c. What is the cost advantage for the Kingdom compared to issuing bonds @ 5.30 %?
d. Same question assuming that the Kingdom wanted to issue an FRN @LIBOR + ¼ %?

The Kingdom of Papou Issues a Very-Bull Bond with a Coupon