Kenmerk : Vellekoop/FMI/2018/TutA/5

Datum : 5 december 2018

Course : Tutorial Answers FMI 2018, part V

1. Swaption Price.
Use Black’s swaption formula (and note that maturity of swaption equals 2 years, not 5
years). Forward swap rat is 4.6942% and swaption price is 1.3207% of notional.
2. Hull-White Calibration

a. Substitute t = 0 in the Hull White formula for continuous time and check that you find
back the observed values d0,T .
b. We have that B̃1 = ∆t and B̃2 = 2∆t − α(∆t)2 , so
−1
Ft,t = ∆t [−rt B̃1 ] = rt
−1
Ft,t+∆t = ∆t [−rt (B̃2 − B̃1 ) − B1 Θ(t)∆t + 21 ∆t(σ r )2 (B̃1 )2 ]
= rt − αrt ∆t + Θ(t)∆t − 21 (σ r )2 (∆t)2 .

Ft,t+∆t −Ft,t
c. By substitution of results of b. in expression ∆t and rewriting you find the
result as stated.
3. Put-call parity is a result for the price difference between call and put so we now look at the
price difference between a payer and receiver swaption.
Let Pt be the value of the payer swaption with maturity T and Rt the receiver swaption with
the same maturity, then we have that the difference of their payoffs at maturity PT − RT
equals LA(sT − sK ) in the notation of Hull. This is the payoff of a forward payer swap
contract with strike sK at maturity. This means (by no arbitrage) that today’s value Pt − Rt
must equal today’s value of that forward swap contract, so Pt − Rt = LA(s0 − sK ), in the
notation of Hull.
4. If d0,t = exp(−tyt ) has a lognormal distribution than −tyt has a normal distribution so
yt also has a normal distribution which means that it can always assume negative values:
P(yt < 0) > 0.
5. Using Itô’s Lemma on d(e−(T −t)R(t,T ) ) gives that the volatility (the term which is in front
of the Wiener increment dz) equals −(T − t)σe−(T −t)R(t,T ) which becomes zero when t ↑ T .
This is as expected since we know that the zero coupon bond value converges to the constant
1 when t ↑ T .