R
Risc1
Member
One of the Chapter 3 assignments X3.7 considers a swaption with an underlying swap of pay 4% fixed and receive floating at a future date.
Given the information in the question the value of the forward swap rate for this swap is about 4.33%. Is the person holding this option 'in the money'?
The question then asks if the vol of the swap rate increased would the swaption increase in value:
I understand that the value of the option would always be higher, the solution indicates that as the volatility of the swap rate increases the probability of the option expiring in the money is higher. Would this be the case if the option was out of the money?
Secondly the solution indicates that the higher volatility would result in a higher probability of the swap rate falling further which would result in greater profits on exercise. Is this correct? Surely if the swap rate fell below 4% I would prefer not to pay 4%, but the lower rate?
Pls help, maybe I am completely misunderstanding the basic principles.
Given the information in the question the value of the forward swap rate for this swap is about 4.33%. Is the person holding this option 'in the money'?
The question then asks if the vol of the swap rate increased would the swaption increase in value:
I understand that the value of the option would always be higher, the solution indicates that as the volatility of the swap rate increases the probability of the option expiring in the money is higher. Would this be the case if the option was out of the money?
Secondly the solution indicates that the higher volatility would result in a higher probability of the swap rate falling further which would result in greater profits on exercise. Is this correct? Surely if the swap rate fell below 4% I would prefer not to pay 4%, but the lower rate?
Pls help, maybe I am completely misunderstanding the basic principles.