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

A party that pays the return on an equity index and receives a fixed rate has a swap with no payment due today. If the index rises sharply shortly after an interim settlement date while interest rates are unchanged, the value of the swap to this party is most likely to:

The swap value to the equity payer most likely falls. The index rise increases the value of the equity leg it must pay, while the fixed leg it receives is unchanged because interest rates did not move. Resetting happens only at settlement dates.

  1. Arise, because the fixed receipts become more valuable
  2. Bfall, because the equity payments it owes have increased in valueCorrect
  3. Cremain at zero, because the swap is reset at each settlement

Explanation

The equity payer owes the index return since the last reset. A sharp index rise increases the value of the equity leg owed, while the fixed leg changes only with interest rates, which are unchanged. The swap value therefore falls for the payer; resetting occurs only at settlement dates, not between them.

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