Consider a 3-year quarterly-pay bond to be issued in 180 days with a 7 percent coupon. A 180-day put option on this bond, with an exercise price rate of 7 percent, has a payoff equal to that of a: A) receiver swaption. B) payer swap. C) receiver swap. D) payer swaption. ANS = D The payoff on a payer swaption is equivalent to that of a put option on a bond as described in the question. Can somebody please explain to me the equivalance between the two
If you had a 180-day call option (right to buy) the bond at issuance date (180 days from now) and you exercise the call option, you become the bondholder and will RECEIVE the 12 FIXED payments. Thus it emulates a right to enter into the fixed-leg position in a swap option, aka a receiver swaption. But you have 180-day put option, so probably this will make you go at the other side of the swaption? i.e. you become a FIXED PAYER i.e. a payer swaption. I have no idea how to directly reach to answer D.
it might be easy to figure out the relationship if you think about what’s going to happen to your positions if rates go up or down. both put on the bond and payer swaption benefit from floating rates going up.
i am a little messed up … is the question talking about bonds with embedded call and put option…180 day put is the investor’s option to put the bond ? i am confused!! thanks dinesh and maratikus for your inputs
put on the bond - right to sell the bond at the strike price.
A put on bond gives you a right to sell bond. ie. You will pay fixed. So D. I have seen these kinds of question a lot lately. Just by looking at the definition of each concept you can figure out the result of all these kind question. A classic one is about swap equivalent to call and put interest rate option. If you look at the definition of interest option, the answer is right there.
thank you people …things are clearer now!!