Explanation:
A swap rate is the average of the bid-and-offer rates of the swap agreement.
Calculation: Swap Rate = (Bid Rate + Offer Rate) / 2 Swap Rate = (4.02% + 4.08%) / 2 Swap Rate = 8.10% / 2 Swap Rate = 4.05%
Financial intermediaries post these bid and offer rates when making the market for these swaps. Due to the versatility of swap agreements, it is difficult to find two counterparties with uniform terms. Therefore, financial intermediaries take the position of the counterparty in all swap agreements. The 6-month LIBOR (4.3%) and the 6-month risk-free rate (3.9%) are not directly used in calculating the swap rate; rather, the swap rate is derived from the bid-offer spread quoted by the financial intermediary.
Q.714 Faheem Salami has recently joined a large investment bank that acts as a financial intermediary in a number of swaps agreements. The bank also acts as the market maker when the counterparties to swaps are unavailable. Salami's boss asked him to calculate the swap rate of the 6-month interest rate swap when the 6-month LIBOR is 4.3%. Salami also knows that the 6-month risk-free rate is 3.9%, and the bid and offer rates for the swap are 4.02 and 4.08, respectively.
Which of the following rates is the accurate swap rate for the specific swap agreement?
A
3.90%
B
4.05%
C
4.10%
D
4.30%
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