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A three-year floating rate bond pays annual coupons of one-year Libor (set in arrears) and is capped at 5.600%. The Libor swap curve is as given in the below table (i.e, 1 year = 2.5%, 2 year =3.0%, 3 year = 3.5%, respectively), and interest rate volatility is 10%. The par value is $100.
Maturity (year)
Par Rate (%)
Spot Rate (%)
One Year Forward Rate (%)
1
2.500
f(0,1) = 2.500
2
3.000
3.008
f(1,2) = 3.518
3
3.500
3.524
f(2,3) = 4.564
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