Question

XYZ Corp owns a 3-year $10 million par floating rate bond. The coupons on the bond are 12-month LIBOR. XYZ would like to hedge against interest rates falling by entering into an interest rate swap with a $10 million notional that receives a fixed rate and pays a floating rate (12-month LIBOR). You are given the following prices for zero coupon bonds. Years to Maturity Zero-coupon Bond Price 1 0.99 2 0.97 3 0.93 Calculate the fixed rate XYZ Corp would receive on the swap.

Answer 1

Answer:

 2.45%

Explanation:

The computation of the fixed rate is shown below:

Years to maturity   Zero coupon  bond price  YTM      Forward rate

1                                 0.99                     1.01%  

2                                      0.97                             1.53%       2.06%

3                                      0.93                            2.45%     4.30%

The fixed rate should be equivalent to the YTM of the 3 year bond i.e. 2.45% the same is to be considered