What must be the annualized two-year spot libor rate

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Reference no: EM132199569

Question - Analyze a two-year swap agreement to exchange LIBOR for fixed-rate payments on a $100 million notional principal. The first payment will be made in one year; the second in two years. You have the following information on LIBOR rates: One-year spot rate is 3% per year. Forward rate in the second year is 5% per year.

What must be the annualized two-year spot LIBOR rate?

Find the floating-rate payments to be made.

Find the present value of the floating-rate payments.

Find the fixed rate that would price the swap correctly.

Now suppose that at T=1, just after the first payments were made, interest rate over year two turns out to be 6% per year (instead of 5% originally estimated). Which party is at a loss now: the one making the fixed payments, or the one making the floating payments? Which party faces credit risk?

Reference no: EM132199569

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