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

Which statement best describes the fixed rate set on a plain vanilla interest rate swap at initiation?

The swap fixed rate at initiation is the rate that makes the present value of the fixed payments equal the present value of the expected floating payments. The swap therefore has zero value to both counterparties and no upfront payment is required.

  1. AThe rate that gives the swap zero value to both partiesCorrect
  2. BThe rate equal to the expected spot rate at the first reset date
  3. CThe rate equal to the longest-maturity spot rate in the term structure

Explanation

The swap fixed rate is set so that the present value of the fixed payments equals the present value of the expected floating payments. The swap then has zero value to both counterparties at initiation. It is a weighted average of forward rates, not the first expected spot rate or the longest spot rate.

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