Hi ,
In the derivatives section class work question 43 solution it is written that ‘A swap can be replicated by a series of forward contract that expire on each of the payment dates, but the fixed rate on these forward contracts are not necessarily equal’. It here mentions that the fixed rate i.e price of FRA replicating a swap maynot be equal . However in the 114 question in Home work section it is written that ‘ We require each of the FRAs to have an FRA rate equal to the swap fixed rate to replicate the payoffs of the swap’.
can someone clarify wheather FRA rates should be same or different?
By the definition of swaps and the valuation done using replication method says that swaps can be created by using different forward rates, it can be some of the forward contracts would have positive values and some would have negative values, but their combined values would equal zero. In this question it mentions about the payments being fixed for fixed for floating bonds where in one party pays fixed payment and one pays floating payments – so the party who is paying fixed payment for that party the payment are equal. The key word here is payment.
the prices of the implicit forward contracts embedded in a swap will not be equal but But for a swap, all the fixed payments are equal.
i hope it helps