Structuring : How would you replicate this Bond ?

[Ubernoobguy]

Hi,

I’m an engineering student interested in finance following my first derivatives course and I am really struggling with the following bond valuation: that’s why I am calling for your help J

Let’s assume a bond with a final maturity of 9 years. The coupon rate for the first 3 years would be 2.5%. The coupon rates for the next two 3-years periods would be determined in 2015 and 2018, respectively. Then, the interest rate
for the next 3 years would be set equal to the market interest rate prevailing at the respective date if the market interest rate surpasses a guaranteed interest rate which are an interest rate of 4.5% for the period 2015-2018 and 6.5% for the last period. In addition, investors would have the option to be reimbursed at par in 2015 and 2018.

Its part of an assignment, I really thought hard about it, but I am still not sure about my conclusion,
Can this bond be replicated by a collection of a Fixed Rate Bond with a fixed rate of 2.5%, 2 Swaptions (to lock the prevailing interest rate) and 2 Puts (for the option to be reimbursed at par)?

Thank you guys !

 

[quotes]

You said "if" in setting the future rates. How about "elseif"?

If the spot rate set in future is only determined by the spot market rate then, you can replicate the rates by swap or whatever. For you are just hedging the future rate, by forward contract on future rates. However, if the spot rate set in future is determined by an "if" clause like the structure of a call or put, there is no static hedge by future and spot instruments.

 

[Ubernoobguy]

Thanks for the answer, yes it is stated "if", that's why i thought about options, i am just not sure about whether I should use options on individual forward rates or options on portfolios of forward rates?