International Financial Management 6th Edition by Sanjiv Eun, Cheol Resnick, Bruce Sabherwal

Exercise 16

Karla Ferris, a fixed income manager at Mangus Capital Management, expects the current positively sloped U.S. Treasury yield curve to shift parallel upward.
Ferris owns two $1,000,000 corporate bonds maturing on June 15, 1999, one with a variable rate based on 6-month U.S. dollar LIBOR and one with a fixed rate. Both yield 50 basis points over comparable U.S. Treasury market rates, have very similar credit quality, and pay interest semi-annually.
Ferris wished to execute a swap to take advantage of her expectation of a yield curve shift and believes that any difference in credit spread between LIBOR and U.S. Treasury market rates will remain constant.
a. Describe a six-month U.S. dollar LIBOR-based swap that would allow Ferris to take advantage of her expectation. Discuss, assuming Ferris' expectation is correct, the change in the swap's value and how that change would affect the value of her portfolio. [No calculations required to answer part a.]
Instead of the swap described in part a, Ferris would use the following alternative derivative strategy to achieve the same result.
b. Explain, assuming Ferris' expectation is correct, how the following strategy achieves the same result in response to the yield curve shift. [No calculations required to answer part b.] c.Discuss one reason why these two derivative strategies provide the same result.