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CFA Level I Exam · Forward Commitment and Contingent Claim Features and Instruments

Swaps as a Series of Forward Commitments: CFA Level I

Updated 7 October 2026 · Fact-checked

A swap is an agreement to exchange cash flows on set dates, so it works like a series of forward contracts. In a plain vanilla interest rate swap, one side pays fixed and the other pays floating on the same notional. Only the net amount changes hands: (fixed rate − floating rate) × notional × period fraction.

Understand Swaps

A swap is a contract in which two parties agree to exchange a series of cash flows over time. It is a forward commitment: both sides must perform, and neither pays a premium at the start. Think of it as a bundle of forward contracts, each settling on a different date. Unlike a single forward, one swap fixed rate applies to every date.

The plain vanilla interest rate swap is the base case. One party, the fixed-rate payer, pays a fixed rate on a notional principal. The other party, the floating-rate payer, pays a floating rate (such as SOFR) on the same notional. The notional is never exchanged. It only sets the size of the interest payments. Payments are usually netted, so only one party sends the difference.

The floating rate is normally set at the start of each period and paid at the end (set in advance, paid in arrears). So the payment on a given date uses the rate observed at the previous date. The fixed-rate payer gains when floating rates rise and loses when they fall. The floating-rate payer is the opposite.

A currency swap exchanges interest payments in two currencies, such as USD and EUR. Unlike an interest rate swap, notional principal is usually exchanged at the start and returned at the end, at the agreed exchange rate, although the exchange is optional. Each leg can be fixed or floating. Interest is paid on each currency's own notional and is normally not netted, because the amounts are in different currencies.

An equity swap exchanges the return on a stock or index for a fixed rate, a floating rate, or another equity return. The equity payer pays the equity return and receives the fixed or floating interest leg. The counterparty pays the interest and receives the equity return.

The equity return can be negative. If the index falls, the equity payer does not pay anything on the equity leg. Instead, the equity payer receives the amount of the decline from the counterparty, and it also receives the interest payment. So the equity payer's net payment (equity leg minus interest leg) is negative, which means a net receipt equal to the interest plus the decline.

Look at it from the counterparty's side. It pays interest and receives an equity return that is negative, so it pays the interest plus the decline. The equity payer has a net outflow only when the equity return is positive and larger than the interest leg.

Key formulas to remember

Net payment, interest rate swap
Net = (Fixed rate − Floating rate) × Notional × (days ÷ day-count basis)
Positive means the fixed-rate payer pays. Negative means the fixed-rate payer receives.
Periodic fixed payment
Fixed payment = Fixed rate × Notional × period fraction
For quarterly payments use 1/4 of the annual rate. Use the day-count given in the question.
Floating payment timing
Payment at date t uses the rate set at date t − 1
Set in advance, paid in arrears.
Equity swap, equity leg
Equity payment = Notional × Equity return over the period
A negative return means the equity payer receives that amount from the counterparty.
Swap as forwards
Swap ≈ series of forward contracts at one fixed rate, with initial value 0
Individual forward legs can have non-zero values, but the total at initiation is zero.

How to solve Swaps questions

Use this order for any swap cash flow question.

  1. 1Identify who pays fixed and who pays floating, and read the notional.
  2. 2Find the period fraction from the payment frequency or day count given.
  3. 3Find the floating rate that applies. Use the rate set at the start of the period, not the end.
  4. 4Compute each leg: rate × notional × period fraction.
  5. 5Net the two legs for interest rate swaps. Subtract the smaller from the larger.
  6. 6Decide direction: if the fixed leg is larger, the fixed-rate payer pays the net amount.
  7. 7For currency swaps, do not net across currencies. Convert only if the question asks, and remember the usual notional exchange at start and end.
  8. 8For equity swaps, treat the equity return as the payment and allow it to be negative.

Quickest way: Fixed minus floating, then sign

When to use it: Use for net payment questions on a plain vanilla swap.

  1. Subtract floating rate from fixed rate. Do this on the rate first.
  2. Multiply by notional and the period fraction once.
  3. If the result is positive, the fixed payer pays. If negative, the fixed payer receives.
  4. Check that the answer is among the three options and the sign matches the story.

Common mistakes in Swaps

  • Using the floating rate at the payment date instead of the rate set at the start of the period

    Students assume the current rate applies.

    Fix: Floating is set in advance and paid in arrears. Use the previous reset rate.

  • Exchanging the notional in an interest rate swap

    Currency swaps usually exchange principal, and the two get mixed up.

    Fix: In a plain vanilla interest rate swap, the notional is never exchanged. In currency swaps it is usual, though not always required.

  • Forgetting to scale the annual rate to the period

    Rates are quoted annually but payments are quarterly or semiannual.

    Fix: Multiply by the period fraction, for example 1/4 for quarterly.

  • Getting the direction wrong

    Students rush the sign of fixed minus floating.

    Fix: Ask who gains when floating rates rise. The fixed payer gains, so when floating exceeds fixed, the fixed payer receives.

  • Saying a swap has a premium or non-zero value at initiation

    Confusion with options.

    Fix: A swap is a forward commitment. It is set at a fixed rate that gives zero value at the start, with no upfront premium.

Worked examples

Example 1

A plain vanilla swap has a notional of $20 million. Payments are quarterly. The fixed rate is 4.00% a year and the floating rate set at the start of the quarter was 4.60% a year. Assuming each quarter is one quarter of a year, what is the net payment and who makes it?

Show the solution
  1. Fixed − floating = 4.00% − 4.60% = −0.60%.
  2. Annual amount = −0.0060 × 20,000,000 = −120,000.
  3. Quarterly amount = −120,000 × 1/4 = −30,000.
  4. Negative means floating exceeds fixed, so the floating payer owes the net.

Answer: The floating-rate payer pays the fixed-rate payer $30,000.

Example 2

A USD/EUR currency swap has a notional of $10 million at an exchange rate of 1.25 USD per EUR. Which statement about the principal is correct at initiation and at maturity?

Show the solution
  1. The EUR notional equals 10,000,000 ÷ 1.25 = €8,000,000.
  2. At initiation, the parties exchange $10,000,000 and €8,000,000.
  3. Over the life, each pays interest on the notional of the currency it owes.
  4. At maturity, the principals are exchanged back at the same original rate.

Answer: Principal of $10,000,000 and €8,000,000 is exchanged at the start and swapped back at maturity at the same 1.25 rate.

Exam tips

  • Read who pays fixed and who pays floating first. Many wrong options reverse this.
  • If the question asks for the net payment, compute the difference in rates before multiplying.
  • Remember that a usual notional exchange, though not always required, is the main difference between currency and interest rate swaps.
  • Eliminate options that show a premium paid or a non-zero value at initiation.
  • With the three-option format, check the sign of your answer. Often two options have the same size with opposite direction.

Practice questions from Forward Commitment and Contingent Claim Features and Instruments

Swaps in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Swaps: frequently asked questions

Why is a swap called a series of forward contracts?

Each payment date is like a forward contract settling on that date. The swap bundles them at one fixed rate. The total value at initiation is zero, though individual legs may not be.

What is the difference between a currency swap and an interest rate swap?

A currency swap involves two currencies and usually exchanges notional at the start and end. An interest rate swap uses one currency and never exchanges notional. Interest rate swaps are netted, while currency swap interest is not netted across currencies.

How do I calculate the net payment on a swap?

Take the fixed rate minus the floating rate, multiply by the notional and by the period fraction. A positive result is paid by the fixed-rate payer. A negative result is received by the fixed-rate payer.

What is a plain vanilla swap?

It is a fixed-for-floating interest rate swap in one currency on one notional. The floating rate is a market reference rate, set at the start of each period and paid at its end.