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Questions and Answers
Which of the following is typically equal to zero at the initiation of an interest rate swap contract?
Which of the following is typically equal to zero at the initiation of an interest rate swap contract?
- Neither its value nor its price.
- Its price.
- Its value. (correct)
An investor could best replicate the position of the floating rate payer in a swap by:
An investor could best replicate the position of the floating rate payer in a swap by:
- borrowing at a fixed rate and entering a series of zero-value FRAs.
- borrowing at a floating rate and entering a series of zero-value FRAs.
- borrowing at a floating rate and buying a fixed-rate bond. (correct)
The price of a fixed-for-floating interest rate swap contract:
The price of a fixed-for-floating interest rate swap contract:
- is established at contract initiation. (correct)
- is directly related to changes in the floating rate.
- may vary over the life of the contract.
For a series of forward contracts to replicate a swap contract, the forward contracts must have:
For a series of forward contracts to replicate a swap contract, the forward contracts must have:
Flashcards
Interest Rate Swap Initiation
Interest Rate Swap Initiation
The price of an interest rate swap is set to zero at initiation.
Replicating Floating Rate Payer
Replicating Floating Rate Payer
Borrow at a floating rate and invest in a fixed-rate bond.
Swap Contract Value Over Time
Swap Contract Value Over Time
The swap's value may change over time as rates vary.
Replicating Swap with Forwards
Replicating Swap with Forwards
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Study Notes
Interest Rate Swap Contract
- At the start of an interest rate swap, its value typically equals zero
- The price of an interest rate swap, referring to the fixed rate in the contract, is structured so the initial value of the swap is zero
Floating Rate Payer Replication
- A floating-rate payer in a swap can be replicated by borrowing at a floating rate and investing in a fixed-rate bond
- This replication exploits the net payments resulting from paying the reference rate and receiving fixed-rate payments
- Alternatively, the position is replicated by taking a floating-rate loan or issuing a floating-rate bond and entering a series of FRAs
Fixed-For-Floating Interest Rate Swap Contract
- The price of a swap contract is structured to have a value of zero when initiated
- While the price is set initially, the value of a fixed-for-floating interest rate swap contract can fluctuate through its duration
Replicating swaps with Forward Contracts
- When using forward contracts to replicate a swap, the series of forward contracts must have values that sum to zero at the swap's initiation
- Each individual forward contract may not have a zero value at initiation, but their combined values should equal zero
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