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Financial Risk Manager Part 2

Financial Risk Manager Part 2

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In order to determine the face values of the 2-year and 10-year swaps, you need to use a system of two equations with two unknowns. Given that the notional amount of the 5-year swap is 100, the equations are based on neutralizing exposure to level PC and slope PC.

To neutralize exposure to level PC, the equation is: F(2)∗(DV01(2)100)∗LevelPC(2)+F(10)∗(DV01(10)100)∗LevelPC(10)+100∗(DV01(5)100)∗LevelPC(5)=0F(2) * \left(\frac{\text{DV01(2)}}{100}\right) * \text{LevelPC(2)} + F(10) * \left(\frac{\text{DV01(10)}}{100}\right) * \text{LevelPC(10)} + 100 * \left(\frac{\text{DV01(5)}}{100}\right) * \text{LevelPC(5)} = 0F(2)∗(100DV01(2)​)∗LevelPC(2)+F(10)∗(100DV01(10)​)∗LevelPC(10)+100∗(100DV01(5)​)∗LevelPC(5)=0

With the available data, this equation becomes: F(2)∗0.0014421+F(10)∗0.00396933+100∗0.00296112=0F(2) * 0.0014421 + F(10) * 0.00396933 + 100 * 0.00296112 = 0F(2)∗0.0014421+F(10)∗0.00396933+100∗0.00296112=0

Solving for F(2)F(2)F(2): F(2)=−0.296112−F(10)∗0.003969330.0014421F(2) = \frac{-0.296112 - F(10) * 0.00396933}{0.0014421}F(2)=0.0014421−0.296112−F(10)∗0.00396933​

To neutralize exposure to slope PC, the equation is: F(2)∗(DV01(2)100)∗SlopePC(2)+F(10)∗(DV01(10)100)∗SlopePC(10)+100∗(DV01(5)100)∗SlopePC(5)=0F(2) * \left(\frac{\text{DV01(2)}}{100}\right) * \text{SlopePC(2)} + F(10) * \left(\frac{\text{DV01(10)}}{100}\right) * \text{SlopePC(10)} + 100 * \left(\frac{\text{DV01(5)}}{100}\right) * \text{SlopePC(5)} = 0F(2)∗(100DV01(2)​)∗SlopePC(2)+F(10)∗(100DV01(10)​)∗SlopePC(10)+100∗(100DV01(5)​)∗SlopePC(5)=0

With the given data, this equation becomes: F(2)∗−0.00083505+F(10)∗0.00001462+100∗−0.00063488=0F(2) * -0.00083505 + F(10) * 0.00001462 + 100 * -0.00063488 = 0F(2)∗−0.00083505+F(10)∗0.00001462+100∗−0.00063488=0

Substituting the previously solved value for F(2)F(2)F(2) into the second equation: −0.579051383∗(−0.296112−F(10)∗0.00396933)+F(10)∗0.00001462−0.063488=0-0.579051383 * \left(-0.296112 - F(10) * 0.00396933\right) + F(10) * 0.00001462 - 0.063488 = 0−0.579051383∗(−0.296112−F(10)∗0.00396933)+F(10)∗0.00001462−0.063488=0

Solving for F(10)F(10)F(10): F(10)=−46.68092564F(10) = -46.68092564F(10)=−46.68092564 which corresponds to a face value of EUR 46.68 million.

Substituting this value of F(10)F(10)F(10) back into the equation for F(2)F(2)F(2): F(2)=−0.296112−(−46.68093∗0.00396933)0.0014421F(2) = \frac{-0.296112 - (-46.68093 * 0.00396933)}{0.0014421}F(2)=0.0014421−0.296112−(−46.68093∗0.00396933)​

Hence, the correct answer to the question is C.

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