Determine most likely rate for double cancellable swap

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Reference no: EM131245152

Double-cancellable swaps Recall that K{10nc x Berm ann} is the fixed rate such that a swap, where we pay fixed for ten years with the right to cancel after x years and annually thereafter, has zero value. Suppose you observe the following rates.
• K{10nc1 Berm ann} 7.20%.
• K{10nc2 Berm ann} 7.10%.
• One-year swap rate 6.10%.
• Two-year swap rate 6.15%. Ten-year swap rate 7.00%.

(a) Bank A wants to pay fixed on a {10nc1 Berm ann} swap to Bank B. However, suppose in addition that Bank B itself has the European option to cancel this swap after one year. Determine the most likely rate for this ‘double-cancellable' swap from the following.
• I > 7.20%
• II 7.20%
• III > 6.10% but
• IV 6.10%

(b) Bank A wants to pay fixed on a {10nc2 Berm ann} swap to Bank B, and once again Bank B has the European option to cancel the swap after one year. Determine the most likely rate for this ‘double-cancellable' swap from the following.
• I > 7.10%
• II 7.10%
• III > 6.15% but
• IV 6.15%

Reference no: EM131245152

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