Reference no: EM131018272

1. Term Structure of Interest Rates. Using the below information for BB rated Euro- 80 denominated global corporate debt (ECP is Euro commercial paper) extract the relevant spot rates to generate a BB corporate yield curve. Note that the maturities are exactly as stated and that corporate debt securities issued in the offshore markets, i.e., London or Luxemburg, typically pay interest only once a year.

(a)    Corporate yield curve in the global EUR market:

Type                                      Maturity              Coupon            Price                   Yield

ECP                                91 days                                                 98.768

ECP                                182 days                                               96.860

Euro-Bond                        1 year               8                                 100.934

Euro-Note                         2 years             6                                  97.760

Euro-Note Strip                  3 years                                                81.401

(b) Draw the corresponding BB yield curve and indicate a hypothetical AAA German Bund term structure, the anchor market for EUR-denominated debt markets, as the relevant sovereign strip yield curve.

(c) What is the relationship between the German sovereign (discount) yield curve and the BB corporate one? Reason by analogy with the US markets and explain.

(d) The Eurozone, i.e., the countries sharing the Euro (EUR) as their common currency, have been in the midst of a long-running debt crisis brought about by sovereign over borrowing, various banking crises, and lax tax collection and enforcement. As a fixed-income strategist for a major mutual fund, you wonder about the wisdom to invest in Greek bonds and collect the relevant data. What is the current German 10Y yield, the corresponding Greek 10Y yield, and the spread between Greek and German 10Y yields? How would you characterize spread and what does it say about market expectations regarding Greek debt?

2. Swap Valuation. The date is January 3, 2012 and you just returned to work from a 80 thorough and exhausting celebration of the New Year. As a junior clerk on the USD fixedincome derivative desk your first transaction of the year involves a 5Y fixed-for-floating swap with yearly payments on $100m notional. Bloomberg provides you with the following data:

Payment Dates                     T-Strip Prices

(Years)                                  P (0, T)

1.0                                          95.39

2.0                                          90.63

3.0                                          85.78

4.0                                          80.93

5.0                                          76.11

(a) In terms of cash-replication, the above 5Y plain vanilla swap corresponds to holding what positions in what type of instruments?

(b) Calculate the 5Y swap rate for an annual fixed-for-floating USD swap. What is an appropriate bid-ask spread assuming that the Bloomberg data are midpoints?

(c) You ponder various strategies to hedge the resulting interest-rate exposure. Describe two different strategies which you could use to hedge the transaction.

(d) Your company has sold a 6Y plain-vanilla swap on 1Y LIBOR precisely one year ago for a swap rate of 7.15%; as a consequence, you receive fixed and pay floating. What value should your accounting system attribute to the swap today (notional principal: $40m)?