Reference no: EM131696896

Question: Suppose practitioners learn that the ICE Benchmark Administration (IBA) will change the panel of banks used to calculate the yen LIBOR. One or more of the "weaker" banks will be replaced by "stronger" banks at a future date. IBA replaced the British Banker's Association (BBA) in 1 February 2014. The issue here is not whether yen LIBOR will go down, as a result of the panel now being "stronger." In fact, due to market movements, even with stronger banks in the panel, the yen LIBOR may in the end go up significantly. Rather, what is being anticipated is that the yen LIBOR should decrease in London relative to other yen fixings, such as Tibor. Thus, to benefit from such a BBA move, the market practitioner must form a position where the risks originating from market movements are eliminated and the "only" relevant variable remains the decision by the BBA.

a. How would a trader benefit from such a change without taking on too much risk?

b. Using cash flow diagrams, show how this can be done.

c. In fact, show which spread FRA position can be taken. Make sure that the position is (mostly) neutral toward market movements and can be created, the only significant variable being the decision by the IBA.