An investor approaches a swap dealer wishing to engage in a total return swap. The underlying asset is $10 million principal amount of a 9% BB-rated 5-year corporate bond that has semiannual interest payments. The swap dealer agrees to pay the total return on this bond for the coming 6 months in return for payments based on (1) an interest rate of 6-month LIBOR plus a spread of 30 basis points and (2) a notional principal amount equal to the face value of the underlying asset, $10 million. At the swap date, the bond is worth par, and the 6-month LIBOR is 6%. Suppose that at the termination date, the value of the bond has still not changed. Determine the net payment and the party that is owed. (Use discrete compounding.) | Financial Risk Manager Part 1 Quiz

An investor approaches a swap dealer wishing to engage in a total return swap. The underlying asset is $10 million principal amount of a 9% BB-rated 5-year corporate bond that has semiannual interest payments. The swap dealer agrees to pay the total return on this bond for the coming 6 months in return for payments based on (1) an interest rate of 6-month LIBOR plus a spread of 30 basis points and (2) a notional principal amount equal to the face value of the underlying asset,$ 10 million. At the swap date, the bond is worth par, and the 6-month LIBOR is 6%. Suppose that at the termination date, the value of the bond has still not changed. Determine the net payment and the party that is owed. (Use discrete compounding.)

Other

Community

TTanishq

Explanation:

Explanation

In a total return swap:

Swap dealer pays the total return on the bond (coupon payments + capital gains/losses)
Investor pays LIBOR + spread

Given:

Notional principal = $10,000,000
Bond coupon rate = 9% (semiannual payments)
LIBOR = 6%
Spread = 30 bps (0.30%)
Bond value unchanged (no capital gains/losses)

Calculations:

Swap dealer's payment to investor:

Coupon payment = $10,000,000 × 9% × 6/12 =$ 450,000
Capital gain = $0 (bond value unchanged)
Total payment from dealer = $450,000

Investor's payment to dealer:

LIBOR + spread = 6% + 0.30% = 6.30%
Payment = $10,000,000 × 6.30% × 6/12 =$ 315,000

Net payment:

Net = $450,000 (dealer pays) -$ 315,000 (investor pays) = $135,000
Since this is positive, the investor receives the net payment

Therefore, the net payment is $135,000 and the investor is the owed party.

Powered ByGPT-5

Financial Risk Manager Part 1

Get started today

Explanation

Comments