Consider a firm that is planning 180 days from now to borrow $250 million using...
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Consider a firm that is planning 180 days from now to borrow $250 million using a five-year, quarterly payment floating rate loan. They are concerned about rising rates, but want to preserve their upside in case rates fall. Suppose that five-year, quarterly payment swaptions expiring 180 days from now are available with a fixed rate of 2.25% at a premium of 75 basis points.
a. What position in the swaption (payer or receiver) would hedge the firms risk exposure and what is the total premium they would pay?
b. Suppose the firm bought the swaption from part a. and, at expiration, the fixed rate that priced a five-year quarterly payment swap was calculated to be 2.32%. Is the swaption in the money?
c. If the firm was not concerned about preserving its upside, what derivative instrument might they use today to hedge the loan risk?
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