Scheweser book 4 fixed income, LOS 32F swap rate curve. I am stuck on how to calculate this and its driving me nuts.

Can someone break down the mathematical sequence to solve the swap fixed rate tenor of 2 years and get their answer 3.98%? The answer is #2 below, but I have no idea how to get solve for it.

Problem starts:

Example: Swap rate curve

Given the following Libor spot rate curve, compute the swap fixed rate for a tenor of  1, 2 and 3 years (i.e., compute the swap rate curve).

Maturity                 Spot Rate

1                              3.00%

2                              4.00%

3                              5.00%

1) SFR1 can be computed using the equation:

SFR1/(1+S1) + 1/(1+S1) = 1

SFR1/1.03 +1/1.03 = 1; SFR1 = 3.00%

2) SFR2 can be similarly computed:

SFR2/(1+S1) + SFR2/(1+S2)2 +1/(1+S2)2 =1

SFR2/1.03 + SFR2/(1.04)2+ 1/(1.04)2 =1; SFR2 = 3.98%

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Scheweser book 4 fixed income, LOS 32F swap rate curve. I am stuck on how to calculate this and its driving me nuts.

Can someone break down the mathematical sequence to solve the swap fixed rate tenor of 2 years and get their answer 3.98%? The answer is #2 below, but I have no idea how to get solve for it.

Try this:

SFR2/1.03 + SFR2/(1.04)2 + 1/(1.04)2 = 1

(1/1.03)SFR2 + (1/1.042)SFR2 = 1 − 1/(1.04)2 = 1 – 0.9246 = 0.0754

0.9709SFR2 + 0.9246SFR2 = 1 − 1/(1.04)2 = 1 – 0.9246 = 0.0754

(0.9709 + 0.9246)SFR2 = 0.0754

1.8955SFR2 = 0.0754

SFR2 = 0.0754 / 1.8955 = 0.0398 = 3.98%

Simplify the complicated side; don't complify the simplicated side.

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you need to first calculate the implied forward rate given the spot rates

let its be the spot rate of interest for t years,

it1,t2 be the implied forward rate of interest from years tto t2.

it1,t2= (1+ it2)t2 / (1 + it1)t1 - 1

(a proper financial math book explains in detail how to get to this formula, which is fundamental in finance. if scheweser book doesnt show this, maybe you deserve a refund). it should also be noted that this formula is only applicable for single periods. multi-period implied forward rate is slightly different)

the implied forward rate for year 0 to 1 is just the spot rate, so i1= i1= .03

the implied forward rate for year 1 to 2 is:

i2= (1.04/ 1.031) - 1 = .050097087

the swap rate is calculated as follows:

sum from t = 1 to n of [it1,t2x (1 + i s-t  ] / [sum from t = 1 to n of ( 1+ it)-t ]

thus:

(.03 x 1.03 -1 + .050097087 x 1.04 -2 ) / (1.03 -1 + 1.04 -2 ) = .039802993 = 3.980%

Hey S2000Magician, thanks for this. It worked! Do you know why it doesn’t work when I do it this way? Is it the order or operations? Many thanks.

SFR2/1.03 + SFR2/(1.04)2 + 1/(1.04)2 = 1
SFR2/1.03 + SFR2/(1.04)2  = 0.0754
SFR2/1.03 + SFR2  = 0.0754 * (1.04)2
SFR2/1.03 + SFR2 ​​​​​​​ = .08155
SFR2 + SFR2 ​​​​​​​ = .08155 * 1.03
SFR2 + SFR2 ​​​​​​​ = .084

SFR2  = .042   ​​​​

Hey Thanks for this, but its too complex for me to understand.. S2000Magician way worked for me. Thanks Again

Whatever you do to one side of an equation, ya hafta do to the other!!! have a look at where you multiplied the left hand side by 1.04and later by 1.03. “Mmmmmm, something…” - H. Simpson

Whatever you do to one side of an equation, ya hafta do to the other!!! have a look at where you multiplied the left hand side by 1.04and later by 1.03. SFR2/1.03 + SFR2/(1.04)2  = 0.0754
SFR2/1.03 + SFR2  = 0.0754 * (1.04)2

Here, for example, you forgot to multiply SFR2/1.03 by 1.042.  If you multiply one term by something, you have to multiply every other term by that same something.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

thank you

S2000magician wrote:

Whatever you do to one side of an equation, ya hafta do to the other!!! have a look at where you multiplied the left hand side by 1.04and later by 1.03. 