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

At initiation of a plain vanilla interest rate swap, the fixed rate is set so that the swap value is zero. Shortly afterward, interest rates rise across the curve. Which outcome is most likely for the swap value?

The swap becomes positive for the fixed-rate payer. After rates rise, the market fixed rate exceeds the locked-in contract rate, so the payer pays less fixed than the market requires while receiving higher floating payments. The fixed receiver loses value.

  1. AIt becomes positive for the fixed-rate payerCorrect
  2. BIt stays at zero for both parties because the fixed rate is locked in
  3. CIt becomes positive for the fixed-rate receiver

Explanation

When rates rise, the market swap fixed rate rises above the contract rate. The fixed payer is paying below-market fixed while receiving higher floating, so the swap gains value for the payer and loses value for the receiver.

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