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Hello Sir, For June 2012 Q3 part (a)
I don’t understand the examiner’s answer
1)why is it using the current annual forward rate to calculate the int payment rather than annual spot yield curve?
2)Why the net payment and net receipt does not have accounted for the +0.6% which the question has mention, its based n the spot yield curve plus 60 basis points?
Hope tutor can clarify it for me, Thank you so much.
1. The spot yield curve rates are the rates as of today for 1, 2 etc years. However the question says that they expect interest rates to rise in the future and the swap receipts from Raitus will be based on whatever the current yield curve rate at the time of the receipt. So the answer is using the forward rates as the ‘best estimate’ of what the actual rates will be in the future years.
2. Part (a) is not asking for the final result of the swap – just what the receipt from Raitus will be. It is in part (b) where we need to take the 0.6% into account (which the answer does do 🙂 )
Thank you, Sir, for the explanation you provided above, as the question only said based on the current yield curve rate so I thought its refer to the annual spot yield curve.
But I still have some concern need you to explain it1)
(i)Why usually the bond int received /payment will be based on annual spot yield curve rather than annual forward rate?
(ii) and why these two rates have so much difference?(for example,y4 difference is 0.9%)
(iii)When do us use annual spot yield and annual forward rate?3)For part (b) the yield int 3% and 4% which examiner used, is it only for assumption/illustration, which we can use another rate as well for calculation?
Thank you for your help as always:)
1. I could understand the problem because of the wording, but when it says the annual payment will be based on the current yield curve it is meaning on whatever the current yield is at the time the payment is made. We obviously don’t know what it will be in the future and so the forward rates are used as an estimate.
The rates are different because investors are expecting interest rates to change in the future and the forward rate is based on what they are expecting in the future.
Yes – you could illustrate using different rates, it doesn’t have to be 3% and 4%.
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