Question

An investor enters into a 2-year swap agreement to purchase crude oil at $51.25 per barrel. Soon after the swap is created, forward prices rise and the new 2-year swap price is $61.50. If interest rates are 1% and 2% on 1- and 2-year zero coupon government bonds, respectively, what is the gain or loss to be made from unwrapping the original swap agreement?

Answer 1

Answer:

The present  Value of Annual Gain for  two years made from unwrapping the original swap agreement is  $20.00

Explanation:

From the given information;

The annual gain from swap agreements = $61.50 - $51.25

The annual gain from swap agreements =  $10.25

Annual rate for the first year = 1% = 0.01

Annual rate for the second year = 2% = 0.02

However the present gain for the first year will be;

$= \dfrac{Annual \ Gain}{(1+r_1)^1}$

$= \dfrac{10.25}{(1+0.01)^1}$

= 10.14851485

The present gain for the second year will be;

$= \dfrac{Annual \ Gain}{(1+r_2)^2}$

$= \dfrac{10.25}{(1+0.02)^2}$

= 9.851980008

The present Value of Annual Gain for  two years is:

$= \dfrac{Annual \ Gain}{(1+r_1)^1} + \dfrac{Annual \ Gain}{(1+r_2)^2}$

=  10.14851485  + 9.851980008

= 20.00049486

≅ $ 20.00

The present  Value of Annual Gain for  two years is $20.00