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FRM Part I · FRM Exam Part I · Swaps

A bank has a swap with a corporate client in which the bank pays fixed and receives floating. Market rates then rise sharply across the curve, with the swap's fixed rate unchanged. Which statement best describes the bank's position and exposure?

The swap has positive value to the bank, so the bank bears credit exposure to the client. A fixed payer benefits when rates rise, since it pays an old lower fixed rate and receives higher floating. An asset position means the counterparty's default would cause a loss.

  1. AThe swap has positive value to the bank, so the bank bears credit exposure to the clientCorrect
  2. BThe swap has negative value to the bank, so the bank bears credit exposure to the client
  3. CThe swap has positive value to the bank, so the client bears credit exposure to the bank
  4. DThe swap has negative value to the bank, and the swap has no credit exposure for either party

Explanation

A fixed payer gains when rates rise because it pays a below-market fixed rate and receives higher floating, so the swap is an asset to the bank. Positive value means the counterparty could default on what it owes, so the bank has credit exposure. The negative-value options reverse the gain direction.

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