- CFA Exams
- CFA Level I Exam
- Study Session 14. Derivatives
- Reading 37. Pricing and Valuation of Forward Commitments
- Subject 8. Interest Rate Swap Contracts
CFA Practice Question
Consider a one-year interest rate swap with semi-annual payments. The annualized fixed rate is 7.84%. The term structure of LIBOR spot rates is given as follows:
On day 0: L0(180) = 7.2%, and L0(360) = 8.0%.
On day 90: L90(90) = 7.1%, and L90(270) = 7.4%.
Assume a notional principal of $1 million. What is the market value of the swap from the perspective of the party paying the floating rate on day 90?
A. $5,100
B. $4,200
C. -$4,200
Explanation: Calculate the new present value factors for 90 and 270 days:
PV90(180) = 1 / (1 + 0.071 x 90/360) = 0.9826.
PV90(360) = 1 / (1 + 0.074 x 270/360) = 0.9474.
PV90(180) = 1 / (1 + 0.071 x 90/360) = 0.9826.
PV90(360) = 1 / (1 + 0.074 x 270/360) = 0.9474.
The present value of the remaining fixed payments of 0.0392 (0.0784/2), including the hypothetical notional principal, is 0.0392 x (0.9826 + 0.9474) + 1 x 0.9474 = 1.0231.
As the market value of the remaining payments on day 90, including the hypothetical final notional principal, is 1.0, we discount 1.00 + 0.036 (which is 0.072/2) = 1.036 back 90 days to obtain 1.036 x 0.9826 = 1.0180.
Therefore, the value of the swap is (1.0231 - 1.018) x 1,000,000 = $5,100.
User Contributed Comments 6
User | Comment |
---|---|
danlan2 | (1+0.072/2)/(1+0.071/4)=1.018 is the 90 day forward rate. Note 7.2% and 7.1% are the spot rates. |
tim2 | Have to say I still don't get this stuff. I wonder why the 7.2% is in the calculation but the 8% is not..? |
NIKKIZ | Tim2 - I don't get it either. But the easiest way to calculate the second part is to get the first original rate and divide it by it's corresponding latest rate as follows: [1+ 0.072(180/360)]/[1+ 0.071(90/360)] = 1.01793. I find this easier to understand... |
dakota6789 | Tim2, the 7.2 is in the calculation because that is the 6 month rate |
somk | I believe if i go to sleep, wake up, drink coffee or whatever brain toxic substance, i will understand this stuff. and i believe i can fly |
wuyiheng | pig can fly |