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FRM Part I · FRM Exam Part I · Swaps

Since the move away from LIBOR, collateralized derivatives are typically discounted using an overnight risk-free rate (OIS). Compared with discounting at a higher, credit-sensitive rate, which is the effect on the present value of a fixed-rate payer's swap that is in-the-money (positive value) from the fixed payer's view because rates have risen?

The value is higher under OIS discounting. An in-the-money swap represents net expected receipts, and discounting them at the lower overnight risk-free rate gives a larger present value than using a higher credit-sensitive rate. Collateral reduces credit exposure but does not set the swap's value to zero.

  1. AThe value is higher with OIS discounting, because lower rates raise the present value of the net receiptsCorrect
  2. BThe value is lower with OIS discounting, because the floating leg is discounted less
  3. CThe value is unchanged because discounting affects only the fixed leg
  4. DThe value becomes zero because collateral eliminates exposure

Explanation

A positive-value swap has net expected receipts. Discounting those at a lower OIS rate gives larger present values than discounting at a higher rate. The value is not unchanged since both legs' net flows are discounted, and collateral does not make the mark-to-market zero.

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