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CFA Level I · CFA Level I Exam · Pricing and Valuation of Interest Rate and Other Swaps

A company has a USD 30 million floating-rate loan and enters a 3-year pay-fixed, receive-floating swap on the same notional with the same reset dates and reference rate. The most likely effect on the company's net cash flows is that it:

The company most likely converts its floating-rate borrowing into an effectively fixed-rate one. The floating amount received on the swap offsets the floating interest on the loan, leaving it paying the fixed swap rate. The notional principal is not exchanged, and rate exposure is hedged rather than doubled.

  1. Aconverts its borrowing cost to a fixed rateCorrect
  2. Bdoubles its exposure to changes in the reference rate
  3. Creceives the principal back from the counterparty at maturity

Explanation

The floating receipts from the swap offset the floating interest paid on the loan, leaving the fixed swap payment as the net cost. Exposure to the reference rate is removed, not doubled, and no notional principal is exchanged in a plain vanilla swap.

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