V5. Suppose that some time ago a financial institution agreed to receive 6-month LIBOR and pay 4% per annum (with semi-annual compounding) on a notional principal of $200 million. The swap has a remaining life of 1.25 years; assume that the payments are to be exchanged every 6 months. The LIBOR rates with continuous compounding for 3-month, 9-month, and 15-month maturities are 3.8%, 4.2%, and 4.4%, respectively. The 6-month LIBOR rate at the last payment date was 3.9% (with semiannual compounding). Suppose that the day count convention is ignored. Calculate the current value of the swap (in terms of bond prices) to the financial institution.

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Swaps

A swap is a derivative contract in which two parties are agreed to exchange their cash flows from two different financial instruments for a defined period. In swap contracts, cash flows from one financial instrument are fixed and cash flow from other financial instruments is variable based on the interest rate, exchange rate, and commodity price. Swap contracts are transacted in an over-the-counter system. Swap contracts are utilized to hedge risk and mitigate loss.