Asset Swap Pricing of a Structured Note
May 24, 2005
Team Latte

Asset swap pricing entails the valuation of the various embedded components of a structured note. It is realistic pricing because it shows the investor where the components of a structured note can currently be cashed out in the market and converted into either a fixed or a floating rate note.

A secondary collared FRN is being offered by Investor A in the secondary market to a structured note trader. Comparable maturity floating rate notes of the same issuer are currently trading at LIBOR flat. The trader knows of an investor B who would purchase this note on an asset swap basis at LIBOR + 0.20%.

The characteristics of the Note is:

In the market a 9.5 year LIBOR floor at 5% is currently being bid at 415 basis points upfront. Similarly, 9.50% cap for a 9.5 years is currently being offered at 500 basis points upfront.

Questions:

• If this note has to be decomposed into a portfolio of LIBOR caps and floors, then would be the position of the buyer of the note (long position) be?
• In the above example what should be the trader's bid price to Investor A if the trader wants to make a 10 basis points profit on the transactions?

Solutions:

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