Question

True or false? Currently, 3-month LIBOR is at 1.2%. Furthermore, the 3-month interest rate futures prices for contracts that mature in 3, 6, and 9 months are 98.40, 98.10, and 97.90, respectively. Assuming quarterly resets, the 1-year swap rate is just under 1.7%. Justify

Answer 1

FALSE

LIBOR (London Inter Bank Offer Rate) is floating rate base + floating rate = Effective interest rate.

In this case for 3 months, LIBOR + floating rate = 1.2% + (100 - 98.40)% = 1.2% + 1.6% = 2.8%

for 6 months, LIBOR + floating rate = 1.2% + (100 - 98.10)% = 1.2% + 1.9% = 3.1%

for 9 months, LIBOR + floating rate = 1.2% + (100 - 97.90)% = 1.2% + 2.1% = 3.3%

Difference between 3 & 6 months and 6 & 9 months contract is 0.3% (3.1% - 2.8%), 0.2% (3.3% - 3.1%) respectively.

Assuming the same resets 1 year floating rate will be having difference of 0.1% i.e. for 1 year contract rate will be 100 - 97.80 = 2.2%

for 1 year, LIBOR + floating rate = 1.2% + (100 - 97.80)% = 1.2% + 2.2% = 3.4%

Hence the above statement is false as 1 year swap rate cannot be under 1.7%.