MFIN6003 Derivative Securities Dr.

Huiyan Qiu

Session Five/Six: In-Class Exercise on Swaps

1. The XYZ Inc. will need 100,000 barrel of oil in year 3. The company wants to hedge the
future price risk. Based on the following information on the zero-coupon bond prices and oil
ap price ha ill be he compan hedged ca h flo in ear

year 1 2 3 4
oil swap price 43.5 45 44 44.5
zero-coupon bond price 0.9852 0.9701 0.9546 0.9388

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MFIN6003 Derivative Securities Dr. Huiyan Qiu

2. Suppose that the oil forward prices for 1 year and 2 years are $20, and $22. The
continuously compounding 1-year interest rate is 3% and 2-year interest rate is 4%. (That is,
the discount rate for year-1 cash flow is 3% and the discount rate for year-2 cash flow is 4%.)
a. What is the 2-year swap price?
b. Suppose you are the dealer who is receiving the fixed oil price and paying the
floating price. Suppose that immediately after you enter into the swap, 1-year
forward price increases by $1 and 2-year forward price increases by $2 and the
interest rates are changed from 3% to 3.5% and from 4% to 4.5%. What happens to
the value of your swap position?
c. What hedging instrument would have protected you against price risk in this position?