Bermudan exercise
(a) Suppose you own a 1yr-into-5yr Bermudan receiver swaption with strike 6%. The underlying swap has quarterly payment dates, fixed versus three-month libor. The exercise dates are quarterly. In one year's time you must determine whether to exercise the first option to receive fixed on a five-year swap, based on the then current interest rate scenario. For each scenario A-F in Table 1 for interest rates in one year's time, determine the most appropriate response to the question ‘Should the first option be exercised?' from the following choices.
I Yes, the option should definitely be exercised.
II No, the option should definitely not be exercised.
III It depends upon current levels of other market variables such as European swaption prices.
![441_Table 1.jpg](https://secure.tutorsglobe.com/CMSImages/441_Table%201.jpg)
(b) Suppose you are told volatilities are zero for all interest rate options, that is, all out of-the-money-forward options have zero value. Again answer the question ‘Should the first option be exercised?' for scenarios D, E and F in Table 2.
![2071_Table 2.jpg](https://secure.tutorsglobe.com/CMSImages/2071_Table 2.jpg)