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FRM Part I · FRM Exam Part I · Introduction to Derivatives

In a plain vanilla interest rate swap, Party A pays a fixed rate and receives floating, with a notional principal of USD 50 million. Which statement about the notional principal is correct?

The notional principal in a plain vanilla interest rate swap is only a reference amount for calculating the fixed and floating interest payments. It is not normally exchanged, because both legs use the same currency and principal swaps would offset each other, unlike in currency swaps.

  1. AIt is exchanged between the parties at inception and returned at maturity
  2. BIt is used only to calculate the periodic interest payments and is not normally exchangedCorrect
  3. CIt is paid by the fixed-rate payer to the floating-rate payer at maturity
  4. DIt is exchanged only if the floating rate rises above the fixed rate

Explanation

In a plain vanilla interest rate swap the notional is a reference amount used to compute payments. Because both legs are in the same currency, exchanging principal would have no value, so it is not exchanged. Principal exchanges are typical of currency swaps.

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