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

An analyst compares a plain vanilla interest rate swap with a portfolio consisting of a long position in a fixed-rate bond and a short position in a floating-rate note, each with the same principal. Which statement best describes the swap's initial value, assuming it is priced at market with a fair fixed rate?

The swap's initial value is zero because the fair fixed rate makes the fixed-rate bond and the floating-rate note equal in value, both at par. Neither counterparty pays anything upfront, so the portfolio replicating the swap has no net value at initiation.

  1. AIt is zero, as the bond and the note have equal initial valuesCorrect
  2. BIt is positive for the fixed-rate payer, as the bond is priced at a premium
  3. CIt is negative for the floating-rate payer, as the note is priced at par

Explanation

A fair swap fixed rate is set so that the present value of fixed payments equals the present value of floating payments. Equivalently, the fixed-rate bond and the floating-rate note both are worth par at initiation, so the net value is zero for both parties. The other options imply a nonzero initial value.

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