Financial Instruments 2025
Tutorial 2 - Forward Rate Agreements & Interest Rate Swaps
Problems
#1 If the 3- and 6-month simple interest rates are 5% and 5.5%, respectively, and a 3x6 FRA is available at 5.5%,
determine how much arbitrage profit can be made in 6 months’ time, assuming a FRA nominal of R1000.
#2 On 21 December 2022, bank A shorts R200 million 3x6s at 5.95%. The 6-month deposit rate is 6.07%. Calculate
the following:
(a) the dates of the near and far legs of the FRA;
(b) calculate how much the bank would gain or lose if the 6-month deposit rate increased from 6.07% to 6.17%
and the 3-month deposit rate decreased by 5 bps;
(c) Assuming the FRA settles in advance, calculate the payoff/settlement due to the bank if 3-month JIBAR
resets at 5.15%.
#3 Forward Rate Agreements & Interest Rate Swaps Practical
Complete the practical ”Interest Rate Swaps”. The relevant Microsoft Excel workbooks for this practical will
be provided to you on our Amathuba site.
#4 Non-Standard Interest Rate Swaps - Roller Coaster Interest Rate Swaps
At the current date t0 , assume the existence of a term structure of simple and continuously compounded default-
free spot interest rates, denoted by {R(t0 , t)}t≥t0 and {r(t0 , t)}t≥t0 respectively, with associated capitalisation
and discount factors {C(t0 , t)}t≥t0 and {Z(t0 , t)}t≥t0 respectively.
Consider a Roller Coaster Interest Rate Swap (RCIRS) with fixed simple swap rate K, initiated at date t0 ,
expiring at date tn , with reset dates {t0 , t1 , t2 , . . . , tn−1 }, referencing floating rates {R(ti−1 , ti ); 1 ≤ i ≤ n},
varying nominals {Ni ; 1 ≤ i ≤ n} and with payment dates {t1 , t2 , t3 , . . . , tn }, i.e. a different nominal amount
applies to each payment period. At each ti ∈ {t1 , t2 , t3 , . . . , tn }, the following cash flows occur:
• floating cash flow: Ni R(ti−1 , ti )τi ,
• fixed cash flow: Ni Kτi ,
where τi = (ti − ti−1 ) /365 for i ∈ {1, 2, . . . , n}.
(i) Provide one real-world scenario where a RCIRS may be used, and preferred to a standard IRS.
(ii) Derive an expression for the initial fair value of the RCIRS at date t0 . Use no-arbitrage arguments to
justify the “replacement” of future floating rates with their forward counterparts, where necessary.
(iii) Derive an expression for the fair RCIRS rate K within the primary market context.
(iv) Derive a strategy to replicate the RCIRS with standard and forward-starting IRSs.
The following NACC swap zero curve prevails in the South African market on t0 = 13-Jun-2014:
2
t − t0 t − t0
r(t0 , t) = −0.0001 + 0.0025 + 0.055 ,
365 1 365
for t ≥ t0 . This curve gives you access to the complete set of discount factors at the current date t0 .
(v) Compute the fair RCIRS rate for a roller coaster payer swap with semi-annual payments in arrears, over
the next 2 years. The initial notional is R80, 000, the second exchange of payments is based on a notional
of R100, 000 and the final two exchange of payments is based on a notional of R40, 000. The floating leg
references 6-month JIBAR (simple, ACT/365). Generate all reset and payment dates according to standard
South African swap conventions.