This is by far my weakest section. I think I got below 50 on level 1. I am operating under the assumption that as of right now, I will get 0 in this section. I have a bunch of free time between now and June 2 to revise material. Any suggestions on how I should attack derivs? I am not looking to master it but want to be able to pick up a few questions come test day. I want to give no more than a full day or 2 to it.

Items at my disposal, secret sauce, schweser vids and books, q-bank, cfai texts. Your thoughts are most welcome.

Contango/ Backwardation, gamma/ delta/ when it’s highest lowest, inputs to BS, 1-z4/ z1+z2+z3+z4 there I just got you 3 questions. And derivatives honestly isn’t that hard it just has this aura around it. FSA is by far the hardest because there is no logic behind it just rules. Derivs. if you bang it out for 5 hours straight this weekend you can get pretty good at swaps. the z equation i listed is half the battle. The other half is realizing that the floating rate resets every time period so you just need the first cash flow.

I keep getting confused on swaptions. It seems simple, but for some reason I’m getting caught up in the complexities. So, we have the option to enter into a swap. If we want to calculate the market value at expiration when the market rate is higher than the exercise rate on the swap, then do we just take the difference between the two and multiply times the sum of pv factors for the most current LIBOR curve? I take exercise rate as given but for the fixed market rate, do I calculate that the same way we usually calculate on swap for fixed rate?

I think you have it right. It sounds like you are doing a receiver where you receive fixed pay floating. You take the difference at the expiration of the fixed and floating and multiply by the principal. When you’re the receiver and rates rise you’ve lost money you so your option is negative and you’ll have to pay money. That’s the jist but I’m sure dreary could fill it in better.

Three months ago, RRCA purchased a European receiver swaption that is exercisable into a two-year swap with semiannual payments. The swaption has a semiannual exercise rate of 2.75% and a notional principal of $25,000,000. The swaption has just expired, and Merinar asks Jani to determine its cash settlement using the term structure presented below in Exhibit 2. Exhibit 2 Term Structure of Interest Rates (%) Days LIBOR 180 1.95 360 3.68 540 4.11 720 4.65

Ok let’s work through it with a problem might be easier

Using the information in Exhibit 2, the market value of the receiver swaption is closest to: A. $106,250. B. $495,508. C. $687,500.

Coud someone explain with this has a positive value to the receiver? The fixed rate after you do the calcs is 2.23% semiannually while we are paying 2.75% seems like the receiver would be negative unless I’m getting my terms mixed up.

LIBOR is the floating rate then? and the swaption rate is fixed rate? what number do you guys get? I’m getting B 495,508, I’m a off a few thousand probably because of rounding.

I thought that’s how it works, but where does the exercise rate get factored into the swaption calculation? Can someone walk through the calculations for your problem above?

First you calculate the discount factors (the example of the first one is shown below… if you can’t get the discount factors, forget about the problem…

L180 = 1/((1+(.0195)*(180/360)) = .990344

L360 = .964506

L540 = .941930

L720 = .914913

To calculate the swap rate, use the z-formula: 1-.914913/(.990344 + .964596 + .941930 + .914913 ) = .085087/3.811693 = .022323 (semi-annual).

So to value the swap, you’re basically calculating the payoffs for each time period (.0275 - .022323) and discounting them back every period. That’s it, nothing fancy.

(0.275 - 0.022323) * (.990344 + .964596 + .941930 + .914913) * 25,000,000 = $493,328.3665 (differences due to rounding).

@Steverunner Two questions: why the rates given are in 180, 360 etc. Normally rates gives given in a question are from the date you are trying to do the valuation. In this question, you are past 3 months so I would expect rates for 90, 270 and so on. Is it different in case of swaption?

Second question is that why is principal not considered in this calculation?

Third what does valuation means in a broader sense. Is it the payoff the the swapholder if the holder plans to exercise as of today, which is 3 months past. Let’s say if I calculate 7 months past, will the payoff be right at that moment?

Does swaption have value at the begining and at expiration? I would assume at expiration there should be nothing left I guess.

These questions I have for swaps as well. I am not sure if anyone can answer these.