Continue with the previous question. Show that the payoff is equivalent to that of a call option on a bond with an exercise price of $1 (the par value of the bond).

Correct Answer: At expiration, the market value of a bond with a face (exercise price) of $1 and annual coupon of 6.5% is (0.065 x 90/360) x (0.9908 + 0.9790 + 0.9655 + 0.9489) + 1 (0.9489) = 1.012. The payoff on a call option on this bond with an exercise price of $1 is Max [0, (1.012 - 1)] = 0.012. This is the same as the payoff on the swaption.