Fixed Income Securities
Ted Spread and Swap Spread in a Financial Crisis
Discussion Questions
Due April 12, 2012

Please complete these questions in groups of 2, to hand in. The grade is calculated as part of your participation grade, so participation, as with the last case, can improve your score substantially, even if your calculations aren’t all perfect!

Should Albert Mills do this trade? Back up your answer with the following analyses:

1. Write out the initial transaction and cash flows for the trade based on entering the swap, purchasing the Treasury bond, and borrowing using the repurchase agreement. Assume $1 billion notional principal for the swap and $1 billion face value for the Treasury bond. You may be very …show more content…
According to the paper both the swap and the bond have the same DV01 thus for every 1b.p. increase in the rates of each their values would increase/decrease by $1.7 million.
The value of the swap on 11/19 will be 1,700,000*(426-400)+ 1 billion=$1.442 billion
The value of the bonds would be 1 billion - 1,700,000*(419-420) = $1.17 billion
The accrued interest for the swap’s fixed payment will be 1,000,000,000*0.04/2*14/360 = $777,777.77
The accrued interest for the swap’s floating payment would be 25,100,000*14/360 = $976,111
Furthermore, from bond’s coupon there will be an additional income of 4.5 *9,700,000(number of contracts)= $43,650,000
Finally, for the repo (11/19/08 was Wednesday) there will be an outflow of 14/360*390,000= $15,166.66
Thus, all in all the return on investment would be [(440,000,000+170,000,000+976,111+43,650,000-777,777- 15,166)/21,000,000]* 14/360= 121.08%

c. What would you do at this point? Stay in the trade or get out? Why? Stay..
3. Estimate the unrealized gain/loss on this trade as of November 19 (two weeks after the initial transaction date). Assume the following: repo rate stays at 0.15% for the full two week period with overnight rolling over of the loan (3 days on the weekend!), the fixed swap rate is at 4.5%, the YTM on the Treasury is 4.2%. The Treasury will have an interest