Compute the synthetic spread over LIBOR for a 5-year, 7.5% fixed-rate coupon par bond given the following swap and rate information. Swap: LIBOR flat vs. fixed of +75 bp to the 5-year Treasury yield 5-year Treasury yield: 6.30% In the above question, how would I know whether the bond holder is receiving or giving LIBOR?
he holds a bond with fixed coupon = he receives fixed (right now) So, in the world of cfa problems, you do exactly the opposite with the swap = pay fixed. Imagine: If you already receive a fixed coupon (from the bond you hold), it makes no sense to do a swap to receive another fixed coupon and paying LIBOR (as you don´t receive LIBOR from anywhere, so you would have the risk of LIBOR going up above the fixed coupons you get). fixed = tyield + 75 bps = 6.30% + 0.75% = 7.05% So: a) he receives 7.5% fixed from his bond b) he pays 7.05% fixed in the swap c) he receives LIBOR in the swap So a - b + c = 0.45% + LIBOR Synthetic spread = 45 bps