Swaps & Call

  1. Consider a $10,000,000 1-year quarterly-pay swap with a fixed rate of 4.5% and a floating rate of 90-day London Interbank Offered Rate (LIBOR) plus 150 basis points. 90-day LIBOR is currently 3% and the current forward rates for the next four quarters are 3.2%, 3.6%, 3.8%, and 4%. If these rates are actually realized, at the termination of the swap the floating-rate payer will: A) pay $10,020,000. B) pay $25,000. C) receive $12,500. D) pay $20,000. 2. George Mote owns stock in IBM currently valued at $112 per share. Mote writes a call option on IBM with an exercise price of $120. The call option is sold for $1.80. At expiration, the price of IBM is $115. What is Mote’s profit (or loss) from his covered call strategy? Mote: A) gained $3.00. B) lost $1.80. C) lost $3.20. D) gained $4.80.
  1. c. 2) d.

Answers: 1. D The payment at the fourth (final) settlement date will be based on the realized LIBOR at the third quarter, 3.8%. The net payment by the floating rate payer will be: (0.038 + 0.015 − 0.045) × 90/360 × 10,000,000 = $20,000 2. D Since the option is out-of-the-money at expiration (MAX (0, S-X)), the option is worthless. Also, the stock increased in value from $112 per share to $115 per share, creating a $3 gain. The $3 gain in the stock price is added to the $1.80 gain from writing the (unexercised) call option. Therefore, the total gain is $4.80 ($3+$1.80).

Agreed with cavil — Both D?