Question about effective return

mapleleafs · September 11th, 2006, 6:08 am

If 3 years bond pay 7.5% p.a and then we sell swaption at 180bps premium upfront (assume unexercised at the end), what is the total payoff (effective return) for 3 years? answer is 8.19% p.a., but i don't know how to get this. pls help

Lepperbe · September 11th, 2006, 6:51 am

CF 0 = CF1 / 1+r + CF2 / (1+r)^2 + CF3 / (1+r)^3CF 0 = -100 + 1.8 = -98.20CF 1 = 7.5CF 2 = 7.5CF 3 = 107.5solve for r = 8.20% (almost 8.19% )

Jungix · September 12th, 2006, 6:31 pm

If you don't want to use a solver for the equation (especially in more complicated cases), you can just write in Excel:-98.207.57.5107.5in A1:A4 and find the effective return with =IRR(A1:A4)HTHJungix