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

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

Step-by-step 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;

`= (Annual \ Gain)/((1+r_1)^1)`

`= (10.25)/((1+0.01)^1)`

= 10.14851485

The present gain for the second year will be;

`= (Annual \ Gain)/((1+r_2)^2)`

`= (10.25)/((1+0.02)^2)`

= 9.851980008

The present Value of Annual Gain for two years is:

`= (Annual \ Gain)/((1+r_1)^1) + (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