1. (complete chart) Bank of America sells a 12 year fixed rate bond at 6%. At...

1. (complete chart) Bank of America sells a 12 year fixed rate bond at 6%. At the same time of the issue the company buys a receiver swaption, 6% and paying variable rate based on LIBOR with 5 years remaining to expiration, 2.5% premium. Fill in the table below assuming the exercise of the swaption - complete bond

2. Explain the net effect to BOA

3. Explain the net effect to bondholders

please write legible

Year	LIBOR at Year end	BOA pays to bond holders	BOA pays to swaption	BOA receives from swaption	Net Cost to BOA
1	10%
2	12%
3	9%
4	8%
5	11%
6	7%
7	5%
8	4%
9	6%
10	2%
11	4%
12	7%

Expert Solution

Receiver swaption gives the buyer the option but not the obligation to enter into a swap of receiving fixed rate and paying the variable rate
Now the buyer will only exercise the option is the LIBOR is lower than 6%, that ways he will cover his cost of paying the bondholders through the fixed rate he will receive and pay lower than 6%, therefore his net cost will be lower than 6%
If the LIBOR> 6% the buyer has no incentive to exercise the option because that will increase his cost instead of decreasing it
Premium paid is also a cost and needs to be incorporated in the Net cost
Net cost = BOA pays to Bond holders+BOA pays to swaption+BOA receives from swaption+Premium
Interest paid are negative and interest received are positive
When the swaption is not exercised the cost is 8.5%
For the years it is exercised the cost falls below 8.5%, emboldened in the table below. Cost falling below 8.5% is the benefit of exercising the swaption

Year	Libor	BOA pays to Bond holders	BOA pays to swaption	BOA receives from swaption	Premium	Net Cost
1	10.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%
2	12.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%
3	9.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%
4	8.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%
5	11.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%
6	7.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%
7	5.00%	-6.00%	5.00%	6.00%	-2.50%	2.50%
8	4.00%	-6.00%	4.00%	6.00%	-2.50%	1.50%
9	6.00%	-6.00%	6.00%	6.00%	-2.50%	3.50%
10	2.00%	-6.00%	2.00%	6.00%	-2.50%	-0.50%
11	4.00%	-6.00%	4.00%	6.00%	-2.50%	1.50%
12	7.00%	-6.00%	0.00%	0.00%	-2.50%	-8.50%

jeff jeffy answered 6 months ago

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