Practice Questions for Options Markets & Options Trading (1)

1. In a covered call strategy:

(a) The gross payoff is greater than the net payoff.

(b) The gross payoff is equal to the net payoff.

(c) The gross payoff is smaller than the net payoff.

(d) None of the above is always true.

Answer c. Since the position involves a short call where the premium is received, the net payoff
exceeds the gross payoff.

2. A stock is currently trading at $50. A one-year at-the-money put costs $10. The stock price at the end
of one year can be equally likely to be one of the following three values: {20, 50, 80}. What is the
expected one-year return of a protective put portfolio?

(a)

(b)

(c)

(d)

Answer b. The protective put position is long the stock and long the put. The cost of the protective
put position is $50 + $10 = $60. Given the three possible stock price outcomes, the gross payoff after
one year will be: {50, 50, 80}. The return in these three cases is
= =
. Taking an equally weighted average, the expected return is

FURTHER EXPLANATION OF THE QUESTION:

We should assume the strike price for the put is $ 50 as the question specifies it is an at the money put
option. So given that at option expiry date the stock price is 50 in the first two scenarios the put payoff
will be zero under these two scenarios and -10 if we take into consideration the put premium. Only in
the 3rd scenario the put payoff is 80-50 which is 30 (this is gross payoff and net payoff is 20 when you
take into account the put premium).
3. You sold a call option at strike 120 for a price of $5, and sold a put option at strike 105 for a price of
$3, both options have the same maturity. In what range of stock prices at maturity will you make money
or not lose on your net payoff?

The total premium is 8 cad.

For the call option the payoff is -(St-120)+5 = 125 or less you are in the positive or 0

For the put option the payoff is –(105-St)+5 = 100 or more you are in the positive or 0.

Therefore 100-125.

4. You have $ 80 to invest. You can invest in one of two alternatives. The first is to invest in a stock that is
trading at $80. The second is to buy one-month 80-strike calls on the stock that are currently trading at $
4 each. You expect the stock price to appreciate with a maximum price after a month of $ 90. What is the
maximum return on investment you can generate using stock and options?

a) Using stock the meximum return you can generate is (90-80)/80 = 12.5 %.
b) Using options you can buy 20 calls for 80$. If the stock price reaches $90 then you obtain a
payoff of 20 ( 90-80) /100 = 200 %.

5. You have a short position in a stock which you sold for $50 and a short position in a put option on the
same stock at strike K=45. At maturity the stock price is $ 43, and you close all your positions. What is
your gross payoff?

Your initial position is -St-P

At maturity:

Payoff from stock poesition= (+S0-St) = + 50 – 43 = $7

Payoff from short put = - (K- St) = - ( 45-43) = $ -2

Your gross payoff from -St-P = $5.

6. You have a long position in a stock that you purchased for $ 50, a short position in a call and a long
position in a put, both at strike K=50.

a)Write down the equation for the gross payoff for this position.

b)What is your gross payoff if ST= 55 at maturity?

c)What is your gross payoff if ST= 45?

Answer:

a)Long stock payoff=St – So

short call payoff= -max(St-K)

long put payoff=max(K-St)

Total gross payoff= St-So -max(St-K) + max(K-St)

b) If St>K then put expires worthless and your total gross payoff will be:

St-So -max(St-K) = 55-50 – (55-50) = 5-5 = 0

c) If St<K then call expires worthless and your total gross payoff will be:

St-So + max(K-St) = (45- 50 )+ ( 50 -45) = 0.

7. The stock price is $50. The strike price of a three-month European put option is $52. If the put option
is equal in price to the call option and the stock pays no dividends, then the rate of interest for three
month's maturity is

(a) 4.61%

(b) 9.23%

(c) 12.66%

(d) 15.69%

Answer d. From put-call parity, if the call equals the put, then the stock price must equal the present
value of the strike price, that is, . Solving , we get the value of . The calculation is
.

8. A stock is priced at $50, and the risk free rate is 10 %. A European call and a European put on this
stock both have exercise prices of $40 and expire in 6 months. What is the difference between the
call and the put prices.

From the put call parity: C+PV(K) = S+P

The difference between the put call price = C-P = S-PV(K)

From the information given: 50-40e-0.1*0.5 = 11.95 (the difference between the call and put should be
11.95$. If not there is an arbitrage opportunity.

c) Assume that the call price exceeds the put price by $7 (C-P=$7). Is there an arbitrage
opportunity?

This will create an arbitrage opportunity: $C-P should be 11.95 but it is $7. So you can make an
arbitrage profit by buying the call and selling the put by paying $7 (buy C-P) and then sell the stock
and buy the bond equivalent amount of PV(K) (-S+PV(K)). Your arbitrage profit is 11.95-7=$4.95.

1-The combination of a position in a covered call and a position in a protective put on a stock index
(where the options have the same strike and maturity) is similar to:

a-A leveraged long position in the stock.

b-A leveraged short position in the stock.

c-A long position in a balanced index fund (i.e., long stock and long investment at the risk-free rate).

d-A short position in a balanced index fund. (i.e., short stock and borrowing at the risk-free rate).

Answer c. Let denote the present value of the index and its value at maturity. The payoff at
maturity of the combined portfolio is

Covered Call = -C+S

Protective Put = P+S

K<S T K≥ST

-C+S ST -( ST-K) + ST

P+S K- S T + ST ST

TOTAL K+ S T K+ ST

This payoff may be replicated by buying a share of the index today and investing the present value of ,
so holding the portfolio is equivalent to holding a balanced index fund which invests in the index and
at the risk-free rate.

2-The three-month 100–strike put is priced at $5 and the three-month 120–strike put is priced at $8.
What is the maximum possible net payoff on a bearish vertical spread using these options?

a-$17

b-$7

c-$20

d-$12

The maximum payoff of a bearish vertical put spread is K 2-K1. This is gross payoff. For net payoff subtract
the premium paid. 120-100-(8-5)=117.

3-A long position in a bearish 90/100 call spread plus a long position in a bullish 90/100 put spread for
the same maturity is:

a) An options strategy to short the stock.

b) An options strategy to go long the stock.

c) Always in-the-money at maturity.

d) A sophisticated approach to borrowing money.

Portfolio=

Bearish call spread (90/100) = -C(90)+C(100)

Bullish put spread (90/100)= -P(100)+P(90)

Let us calculate what happens at maturity to the sum of these positions:

ST≤90 90≤ ST ≤100 ST ≥100

-C(90) 0 -( ST -90 ) -(ST – 90)

+C(100) 0 0 ST - 100

-P(100) -(100- ST) -(100- ST) 0

+P(90) (90- ST) 0 0

TOTAL -10 -10 -10

4-What happens to the long position in a 90–100–110–strike call butterfly spread if all the calls are
replaced with puts of identical strike and maturity?

a-There is no change in the risks and cash flows of the original position.

b-The new position is the same as holding a short position in the original call butterfly spread.

c-The new position is the mirror image of the original one if you consider the x-axis as a mirror.

d-The gross payoffs remain the same, but the net payoffs are different.

5-A long position in a strangle is:

a-A short squeeze on a straddle.

b-Worth more than a straddle whose strike lies within that of the strangle.

c-Worth less than a straddle whose strike lies within that of the strangle.

d-A choke hold on someone else’s throat.

6-A combination of a long position in a strip and a long position in a strap for the same strike and
maturity (and with similar but opposite proportions of calls and puts) is similar to:

a-A strangle position.

b-A straddle position.

c-A collar position.

d-None of the above.

Answer= C(100) + 2P(100) + P(100) +2C(100) just as an example would give a position of
3C(100)+3P(100).

7. Compute the gross payoffs for the following two portfolios in separate tables:
• Calls (strikes in parentheses): C(90) − 2C(100) + C(110).

• Puts (strikes in parentheses): P(90) − 2P(100) + P(110). What is the relationship between the two
portfolios? Can you explain why?

Answer:

The short answer is butterfly spread for puts and calls for the same strike and exercise price is exactly
the same;

For proof you can examine the payoff tables for the two portfolios:

The payoffs for the two portfolios are as follows:

As we can see, the payoffs are the same in both tableaus. We can also use the put-call parity to
understand that these two portfolios have exactly the same payoffs:

The reason for this is that the two positions are equivalent given put call parity. Since each call is
equal to a put plus the stock price minus the present value of the strike price (per put-call parity),
then the values of the stock minus strike present value cancel out given that there are two long
option positions and two short option positions in each portfolio. Hence, we get a butterfly spread
payoff in each case, irrespective of whether we use puts or calls.
 8- Draw the payoff diagrams at maturity for the following two portfolios: • A: Long a call at strike K
and short a put at strike K, both options for the same maturity. • B: Long the stock plus a borrowing
of the present value of the strike K. The payoff of this portfolio is the cash-flow received at maturity
from an unwinding of the positions in the portfolio. Compare your two payoff diagrams and explain
what you see.

Answer: The payoff diagrams for both cases are as follows:

Let’s check the value of the C(T)-P(T)portfolio at maturity:

ST<K ST≥K

C(T) 0 ST-K

-P(T) -(K- ST) 0

ST-K ST-K

From the put call parity we know that C(T)-P(T) = S T-PV(K). Therefore their payoffs must be the same.

What doe this payoff structure look like apart from the combination of puts and calls? Think first part of
the semester! (Answer: Long forward contract with the underlying being a stock with a forward price of
K).
OPTIONS PRICING BINOMIAL AND BLACK SCHOLES EXERCISES

BINOMIAL OPTION PRICING

1. In a one-period binomial model, assume that the current stock price is $100, and that it will rise to
$110 or fall to $90 after one month. What is the delta of a 99–strike one-month put option?

(a)

(b)

(c)

(d)

Answer b.

> delta = (0-9)/(110-90)

> delta

[1] -0.45

2. In a one-period binomial model, assume that the current stock price is $100, and that it will rise to
$110 or fall to $90 after one month. If the risk-free rate is 0.1668% per month in simple terms, which
of the following choices best describes the replicating portfolio for one hundred 99-strike one-month
call options?

(a) Long 50 shares of stock and long 50 units of $1 bonds.

(b) Long 55 shares of stock and long 49 units of $1 bonds.

(c) Long 55 shares of stock and short 49 units of $1 bonds.

(d) Long 55 shares of stock and short 50 units of $1 bonds.

Answer c. We solve the following two equations to get the replicating portfolio of shares of stock
and units of risk-free bond:

We get , and .

110 – 99 = 11

110 - 90 = 20
 (0 – 90 * 0.55) / (1 + 0.1668) = -49.41

3. In a one-period binomial model, assume that the current stock price is $100, and that it will rise to
$115 or fall to $80 after three months. If risk-free investment has a gross return of 1.005 per three
month time-step, what is the best replicating portfolio of one hundred 101–strike three-month put
options from the following options?

(a) Short 60 shares of stock and long 69 units of $1 bonds.

(b) Short 65 shares of stock and long 70 units of $1 bonds.

(c) Short 65 shares of stock and short 69 units of $1 bonds.

(d) Short 65 shares of stock and short 70 units of $1 bonds.

Answer a. We solve the following two equations to get the replicating portfolio of shares of stock
and units of risk-free bond:

We get , and .

4. Which of the following statements best describes the delta of vanilla options?

(a) Call and put deltas are both positive.

(b) The call delta is positive and the put delta is negative.

(c) The call delta is negative and the put delta is positive.

(d) Call and put deltas are both negative.

Answer b.

5. Which of the following statements best describes the range of possible values of the delta of a call
option?

(a) Lies between and .

(b) Lies between and .

(c) Lies between and .

(d) Lies between and .

Answer b.

6. You hold a portfolio of European options on a stock that is (i) long 200 at-the-money calls, each with
a delta of , (ii) short 200 at-the-money puts, and (iii) long 100 shares of stock. The aggregate
delta of your portfolio is
 (a) 100.

(b) 108.

(c) 300.

(d) Cannot be calculated from the given information.

Answer c. The delta of the put can be calculated from the delta of the call, and is seen to be .
So the portfolio delta is .

7. You hold a portfolio consisting of 300 calls (short) and 200 puts (long) on a given stock. The delta of
the calls is and the delta of the puts is . To delta hedge this portfolio, you should

(a) Short 74 shares of the stock.

(b) Buy 300 shares of the stock.

(c) Buy 500 shares of the stock.

(d) Buy 74 shares of the stock.

Answer b.

BLACK SCHOLES EXERCISES

1. The Black-Scholes model differs from the binomial in that

(a) The mathematics it requires is much simpler.

(b) It provides closed-form solutions for option prices, so can price European options faster than the
binomial model.

(c) It can handle stochastic interest rates more efficiently than the binomial.

(d) It was developed after the binomial model and is therefore more current.

Answer b.

2. Which of the following is not an assumption underlying the Black-Scholes model?

(a) The rate of interest is constant.

(b) The dividend rate must be less than the interest rate.

(c) Stock volatility is constant.

(d) There are no taxes and transactions costs.

Answer b. The dividend rate can be larger or smaller than the rate of interest.
3. A stock is currently trading at . It is not expected to pay dividends over the next year. You
price a six-month put option on the stock with a strike of using the Black-Scholes model and
find the following numbers:

Given this information, the risk-neutral probability of the put finishing in the money is

(a) 1.7%

(b) 1.832%

(c) 2.115%

(d) 3.3%

Answer d. The risk-neutral probability of the put finishing in-the-money is .

4. A stock is currently trading at . It is not expected to pay dividends over the next year. You
price a one-month call option on the stock with a strike of using the Black-Scholes model
and find the following numbers:

Given this information, the risk-neutral probability of the call finishing in the money is

(a) 71.7%

(b) 64.5%

(c) 76.3%

(d) 74.0%

Answer d. The risk-neutral probability of the call finishing in-the-money is .

5. A stock is currently trading at S0= 37.12. You price a one-month put option on the stock with a strike
of K= 30 using the Black-Scholes model and find the following numbers:

Given this information, the delta of the put is

(a) .
 (b) .

(c) .

(d) .

Answer d. The delta of the put is .

6. A stock is currently trading at . It is not expected to pay dividends over the next year. You
price a one-month put option on the stock with a strike of using the Black-Scholes
model and find the following numbers:

Given this information, the probability of the put finishing out-of-the-money is

(a) 25.3%

(b) 23.0%

(c) 74.7%

(d) 77.0%

Answer b. The probability of the put finishing out-of-the-money is .

7. A call option can be replicated by holding a position in stock and shorting bonds, i.e.,
where is the delta of the call option. Comparing the replication formula to the Black-Scholes
formula (assume a non-dividend-paying stock), what can you say about the delta of the option?

(a) The delta is equal to the probability that the option will end up in the money.

(b) The delta is equal to .

(c) The delta is the short position in stock needed to replicate the option.

(d) There is insufficient information to say anything about the delta.

Answer b. The probability that the option ends up in the money is —so (a) is wrong. It is the
long position in the stock needed to replicate the option—so (c) is wrong.

8. A put option can be replicated by holding a position in stock and bonds, i.e., where
is the delta of the put option. Comparing the replication formula to the Black-Scholes formula, and
assuming no dividends, what can you say about the delta of the option?

(a) The delta is equal to the probability that the option will end up in the money.
 (b) The delta is equal to .

(c) The delta is equal to .

(d) The delta is the long position in stock needed to replicate the option.

Answer c. The probability that the option ends up in the money is , not that is the
correct answer. For puts, it is the short position in the stock needed to replicate the option.

9. Consider a Black-Scholes setting. When a call option is deep in-the-money, an increase in volatility
results in, ceteris paribus,

(a) A decrease in the delta of the option.

(b) A decrease in the insurance value of the option.

(c) An increase in the intrinsic value of the option.

(d) An increase in the time value of the option.

Answer a. This can be derived from the formula, but intuitively, when the option is deep ITM, delta is
close to 1. If volatility increases, the option might be more likely to move to being less in the money.
Hence, the delta decreases.

The Option Greeks and Practice Questions

1. The delta of an option measures, approximately,

(a) The dollar change in option value for a $1 change in the price of the underlying.

(b) The percentage change in option value for a 1% change in the price of the underlying.

(c) The risk-neutral probability that the option finishes in-the-money.

(d) The reaction of the option to a sudden jump in the price of the underlying.

Answer a.

2. The delta of a call option is 0.7. The current price of the call is $7 and the stock is at $75. What is the
approximate price of the call if the stock price decreases to $74.60?

(a) $7.28

(b) $6.40

(c) $6.72

(d) $7.40

Answer c. The new call price will be approximated using the delta as follows:
 Cnew = Cold + ∆c (∆S) = 7 + 0.7 (-0.4) = 6.72

3. The delta of a call option is 0.5. The current price of the call is $4 and that of a put at the same strike
is $5, and the stock is at $102. What is the approximate price of the put if the stock price decreases
to $101.50?

(a) $4.75

(b) $5.35

(c) $5.25

(d) $4.50

Answer c. First, we need find the delta of the put. This comes from the fact that (from
put-call parity). Therefore, 0.5-∆p = 1→ ∆p= 0.5. The new put price is then calculated as follows:

Pnew = Pold + ∆p(∆S) = 6 - 0.5 (-0.5) = 5.25

As is to be expected, the price of the put will rise when the stock price falls.

4. A stock is trading at $70. You hold a delta-hedged portfolio in which you are short a call and long
units of the stock. The delta of the call is 0.4 and the gamma of the call is 0.08. If the stock registers
an unexpected price decrease of $5, the value of your delta-hedged portfolio will

(a) not change.

(b) decrease by approximately $0. 2.

(c) increase by approximately $1.

(d) decrease by approximately $1.

(e) increase by approximately $0. 2.

Answer d. The portfolio value declines by approximately . Here,.

ᴦ (gamma)= 0.08 and dS = -5

As the portfolio is delta hedged the value of the portfolio will change by the amount of the gamma:

½(0.08)(5^2). (If you are not hedging your gamma you will lose this amount when you are short the
option)

5. A stock is currently trading at $50. A three-month at-the-money European put option on the stock
costs 2.178. The delta of the put is and the gamma of the put is 0.063. Given these values,
if the stock price decreases by $5.00, then the best estimate for the new value of the put is

(a) .
 (b) .

(c) .

(d) .

(e) Zero.

Answer b. The change in the put value is given by

which can be positive, negative, or zero, depending on the current level of the stock price.

6. The gamma of an option is

(a) The dollar change in the option delta for a $1 change in the price of the underlying.

(b) The percentage change in option delta for a 1% change in the price of the underlying.

(c) The dollar change in the option price for a sudden unit jump change in the price of the
underlying.

(d) The percentage change in the option price for a sudden unit jump change in the price of the
underlying.

Answer a.

7. The current price of a call is $5 and the stock is trading at $50. The delta and gamma of the call are
0.5 and 0.05, respectively. If the stock price increases to $50.50, then approximate the new call price
using the information given:

(a) $5.24375

(b) $5.25

(c) $5.25625

(d) $5.2625

Answer c. The new call price will be

8. You hold a portfolio of a long position in a call and a short position in a put, both for the same strike
and maturity, both written on a non-dividend paying stock. Which of the following statements is
most correct?
 (a) The delta of the portfolio increases when the stock price increases.

(b) The delta of the portfolio stays the same when the stock price increases.

(c) The delta of the portfolio decreases when the stock price increases.

(d) The delta of the portfolio may increase or decrease when the stock price increases.

Answer b. From put-call parity, note that , irrespective of strike and maturity. The delta
of the portfolio is always a constant 1.

9. You hold a portfolio of a long position in a call and a long position in a put, both for the same strike
and maturity. Which of the following statements is true?

(a) When the stock price increases, the delta of the portfolio increases if the call is in-the-money.

(b) When the stock price increases, the delta of the portfolio decreases if the call is out-of-the-
money.

(c) When the stock price increases, the delta of the portfolio increases whether or not the call is in-
the-money.

(d) There is not enough information to answer this question.

Answer c. The call delta increases when the stock price rises. The put delta also increases when the
stock price rises, i.e., it becomes less negative. Therefore, the sum of the two also increases when
the stock price rises.

10. Which of the following statements is valid for European options?

(a) The gamma of a call is positive and that of a put is negative.

(b) The gamma of a call is negative and that of a put is negative.

(c) The gamma of a call is negative and that of a put is positive.

(d) The gamma of a call is positive and that of a put is positive.

Answer d.

11. Gamma is a risk measure that is related to the volatility (particularly jump-risk) of the underlying
stock. Which of the following is most valid?

(a) When you buy vanilla call options it is useful to hedge away gamma to minimize jump risk.

(b) When you sell vanilla put options it is useful to hedge away gamma to minimize jump risk.

(c) Both (a) and (b).

(d) Neither (a) nor (b).

Answer b. Being long gamma (from buying options) is good as jump-risk works in your favor. But
short gamma positions are vulnerable to large losses from jump-risk even after delta hedging.
12. You expect a sizable jump in the stock price but are not sure of the direction in which the stock will
go. Which of the following alternatives would be best?

(a) Buy call options.

(b) Buy put options.

(c) Sell a straddle.

(d) Buy a call and delta hedge it.

Answer d. In (a) you will lose if the jump is negative. In (b) you will lose if the jump is positive. In (c)
you will lose either way. In (d) the delta-hedged call position has a U-shaped value function so that a
move up or down will result in a gain.

13. You hold a portfolio of European options on a stock that is (i) long 200 at-the-money calls, each with
a delta of , (ii) short 200 at-the-money puts, and (iii) long 100 shares of stock. The aggregate
delta of your portfolio is

(a) 100.

(b) 108.

(c) 300.

(d) Cannot be calculated from the given information.

Answer c. The delta of the put can be calculated from the delta of the call, and is seen to be .
So the portfolio delta is.(0.52x200)+(-0.4x-200) +100 = 300

14. You hold a portfolio consisting of 300 calls (short) and 200 puts (long) on a given stock. The delta of
the calls is and the delta of the puts is . To delta hedge this portfolio, you should

(a) Short 74 shares of the stock.

(b) Buy 300 shares of the stock.

(c) Buy 500 shares of the stock.

(d) Buy 74 shares of the stock.

Answer b.

PRACTICE QUESTIONS FOR SWAPS

1.Firm A can borrow at 4% fixed or at Libor flat in the fixed and floating rate markets, respectively. Firm
B can borrow at 7% fixed or Libor plus 100 bps in the fixed and floating rate markets, respectively. A
wants to borrow floating and B wants to borrow fixed.
 If A borrows fixed and B borrows floating and they enter into a fixed-for-Libor interest-rate swap in
which A pays Libor flat, what is the range of fixed rates for B that enables each firm to improve its
financing costs (compared to accessing financing in the market directly)?

(a) 4%-7%

(b) 4%-6%

(c) 5%-6%

(d) 5%-7%

Answer b. The two parties would enter into a swap at say 5% fixed versus floating Libor. Then, A
would borrow at a fixed 4%, and B would borrow floating at Libor plus 1%. The net result is that A
would obtain floating rate borrowing at a net financing cost of Libor minus 1% (cheaper than accessing
floating finance at Libor in the open market). B would obtain net fixed rate financing at 6% (1% lower
than accessing it directly). It is easy to calculate that in this case both have gained by accessing
financing that is 1% cheaper, i.e., together they obtained a gain of 2%. We can also see that the fixed
rate can be at 4% in which case the entire gain of 2% goes to B, or the fixed rate can be at 6% in which
case the entire gain would go to A. Anything outside these bounds would not work, as then one of the
parties would be better off borrowing without the swap.

2.Firm A can borrow at 4% fixed or in the floating-rate market at Libor flat. Firm B can borrow at 7%
fixed or at Libor bps. A wants to borrow floating and B fixed.
Suppose that to reduce financing costs, A borrows fixed, B borrows floating, and they enter into an
interest-rate swap. Which of the following statements is valid?

(a) The combined improvement in cost of financing to A and B with the swap is always equal to the
difference between the fixed rate differential (between A and B) and the floating rate differential
which in this case is 200 basis points.

(b) The combined improvement in cost of financing to A and B with the swap is always equal to the
floating rate differential, which in this case is 100 basis points.

(c) The combined improvement in cost of financing to A and B with the swap depends on the
negotiated fixed rate on the swap between the two counterparties.

(d) No improvement in combined financing costs is possible—what one party gains in financing
costs, the other party loses.

3.You enter into a $100 million notional swap to pay six-month Libor and receive 8%. Payment dates are
semi-annual on both legs. The last payment date was March 25 and the next payment date is
September 25. Floating payments are based on the USD money-market convention, and fixed
payments are based on the 30/360 convention. If the floating rate was reset to 6% on March 25, what
is the net amount you will receive on Se\\ptember 25? (March 25-Sept 25 is 184 days)
 (a) $933,333

(b) $966,667

(c) $1,000,000

(d) $1,066,667

Answer a. The money market convention is Actual/360, and the number of days from March 25 to
September 25 is 184 days. Hence the floating payment is
. The fixed leg is . Hence, the net amount is $933,333.

4. An FRN has four remaining payment dates:

Time to payment Libor rates as of t0

t1= 135 days 6.33%
t2= 318 days 6.58%
t3= 500days 6.25%
t4= 683 days 6.10%

The FRN has a face value of $1. The first coupon payment is 6.2%. . What is the value of the FRN? The
days to first coupon payment at initiation is 182 days.
(a) 1.015
(b) 1.007
(c) 1.038
(d) 1.117

Answer (b). Value of the FRN=

Discount factor = 1/(1+(6.33%*135/360) = 0.9768

The first coupon payment = 6.2%*182/360 = 0.03134

The value of the FRN at the first coupon reset date = 1+0.03134 = 1.0313

The value of the FRN is the present value of the value of the FRN at first coupon = 0.9768*1.013= 1.007

4- Find the value of the following swap to the fixed payer:

Payment dates: 18 June Yr 1,18 Dec Yr 1,18 June Yr 2, 18 Dec Yr 2, 18 Jun Yr 3.

Payment Dates Days from Present Discount Factors

18 Dec - Yr1 100 0.98146
18 Jun - Yr2 282 0.95084
18 Dec- Yr 2 465 0.93142
18 Jun – Yr 3 647 0.90340
18 Dec – Yr 3 830 0.88385
Swap rate: 5.7 %, LIBOR at last reset: 6% (182 days to first coupon at initiation)
(a)+330,543
(b)-429,368
(c) -516,805
(d)+429,368

Value of the swap instrument to the fixed payer=

Fixed payer is long FRN and short fixed rate bonds. Therefore the value to the fixed rate payer = Value of
the FRN – Value of the Fixed rate Bond.

First find the value of the FRN=

Value of first coupon at the first payment date= (6%*182/360) = 0.0303

Value of the FRN at first reset date = (1+0.0303) = 1.0303
PV of the FRN (For 1 $ Face Value) = 0.98146*1.0303= 1.01123
For 100,000,000 = 1.01123*100,000,000= 101,123,000

Value of the Fixed Rate Swap=

Days from Present Yield Discount Factor Fixed CF PV of fixed CF

100 6.80% 0.98146 2,850,000 2,797,165
282 6.60% 0.95084 2,850,000 2,709,898
465 5.70% 0.93142 2,850,000 2,654,558
647 5.95% 0.90340 2,850,000 2,574,678
830 5.70% 0.88385 2,850,000 2,518,966
830 5.70% 0.88385 100,000,000 88,384,768

(5.7%/2)* (0.98146+0.95084+0.93142+0.90340+0.88385) + 1* (0.88385)= 0.13255+0.88385=1.0164

1.0164*100,000,00=101,640,000

Value to the fixed rate payer = 101,123,000-101,640,000 = -517,000 (the dfference is because of rounding
you need to choose the closest answer)