Synthetic Payer Swaps - Please Help!

CFA Level II Derivatives
#1

For a 1-year quarterly-pay swap, an equivalent position with short puts and long calls would involve:

A)

put-call combinations expiring on each of the four settlement dates.

B)

three put-call combinations on the last three settlement dates of the swap.

C)

three put-call combinations expiring on the first three settlement dates of the swap.

Correct Answer: C

Explanation

Interest rate options pay one period after exercise. Options expiring on settlements at t = 1,2,3, will mimic the uncertain swap payments at t = 2,3,4.

So when an IR option expires the rates are locked in and interest is paid over the same period of the option contract so payoff effectively happens a period (identical to option contract length) after the expiration? Is this what exercising would look like, assuming exercising the options to create the synthetic swap??

#2

if you enter a 1 year qrtly pay swaps.

Lets say you are the payer of variable.

swaps set in advance so you will know what you are paying at Q1
You do not know paying at Q2, Q3, Q4
But the payments are based on what rates will be at Q1, Q2, Q3
Rates up pay more, rates down pay less

If you write a call and go long at put with same strike = fixed rate on swaps = you will have the same payoff.
You need to this for Q2, Q3, and Q4 payments but rate setting times of Q1, Q2, Q3

(I will use days when talking about options so we don’t get mixed up)

If a “90 day LIBOR option” has an expiry day at day 90 setllement is 90 days later, ie at day180.

So you want options the expire on Q1, Q2, Q3 of the swap and they will make payments on the Q2, Q3, Q4 of the swap