Use the zero-coupon bond prices given in the following table to answer the questions that follow.
-Consider a three-year swap receiving floating paying fixed with principal of $10 million,paying a fixed rate of 2 percent per year paid yearly,and receiving the one-year floating spot rate yearly.How would one synthetically construct the swaps payoff at time 3 using FRAs and zero-coupon bonds? (Hint: use the answer to question 11. )

Question

Use the zero-coupon bond prices given in the following table to answer the questions that follow. 
-Consider a three-year swap receiving floating paying fixed with principal of $10 million,paying a fixed rate of 2 percent per year paid yearly,and receiving the one-year floating spot rate yearly.How would one synthetically construct the swaps payoff at time 3 using FRAs and zero-coupon bonds? (Hint: use the answer to question 11. )

Quizplus · Accepted Answer

The correct answer is A because the swap payoff at time 3 is the difference between the fixed payment and the floating payment. The fixed payment is $10 million * 2% = $200,000. The floating payment is $10 million * the one-year floating spot rate at time 3. To synthetically construct this payoff, we can use a FRA and a zero-coupon bond. The FRA will pay us the difference between the fixed rate and the floating rate at time 3. The zero-coupon bond will pay us $10 million at time 3. The notional amount of the FRA should be $10 million and the maturity of the FRA should be time 3. The face value of the zero-coupon bond should be $10 million and the maturity of the zero-coupon bond should be time 3.

Use the Zero-Coupon Bond Prices Given in the Following Table