) WITH RESPECT TO THE SWAPTION, IS MONTERO MOST LIKELY CORRECT

4.) With respect to the swaption, is Montero most likely correct?

A.

No, he is incorrect about the net interest rate paid.

B.

No, he is incorrect about the type of swaption.

C.

Yes.

Answer = A

He is correct about the purchase of the payer swaption. But the net interest payment is

likely to be in excess of 3.5%. If the fixed rate in 60 days is above 3%, the swaption will

be exercised, thus locking in 3%. But the loan has a rate of LIBOR + 0.50%, and the

floating receipt on the swap is LIBOR. So the net effect is that the interest payment will

likely be in excess of 3.5%.

“Risk Management Applications of Swap Strategies,” by Don M. Chance