Suppose that you are a swap bank and you notice that interest rates on zero coupon bonds are as shown.Develop the 3-year bid price of a dollar swap quoted against flat USD LIBOR. $\begin{array}{lccc}
\text { Zero Rates } & 1 \text {-year } & \text { 2-year } & 3 \text {-year } \
\text { USD } & \$ 3 \% & \$ 4 \% & \$ 5 \% \
\text { Euro } & € 2 \% & € 3 \% & € 4 \%
\end{array}$ In other words,what will you be willing to pay in euro against receiving USD LIBOR?
A)5 percent
B)4 percent
C)3 percent
D)2 percent

Question

Quizplus · Accepted Answer

To determine the bid price of the dollar swap quoted against flat USD LIBOR, we need to calculate the fixed rate for a 3-year swap. Here, we will receive USD LIBOR and pay a fixed rate in euros.

Using the given zero rates, we can calculate the discount factors for each tenor:

- 1-year discount factor = 1 / (1 + 3%) = 0.9709
- 2-year discount factor = 1 / (1 + 4%)^2 = 0.9259
- 3-year discount factor = 1 / (1 + 5%)^3 = 0.8638

Next, we can calculate the 3-year swap rate using these discount factors:

- 3-year swap rate = (1 - 0.8638) / (0.9709 + 0.9259 + 0.8638) = 4%

Therefore, we would be willing to pay 4% fixed in euros to receive USD LIBOR. The answer is B) 4 percent.

Suppose That You Are a Swap Bank and You Notice