[Aishwarya chockalingamParticipant]

Ace enters a 10-year GBP interest rate swap with a client in which Ace receives
an initial six-month GBP MRR of 1.75% and pays a fixed GBP swap rate of 3.10%
for the first semiannual period. Six month

Ace enters a 10-year GBP interest rate swap with a client in which Ace receives
an initial six-month GBP MRR of 1.75% and pays a fixed GBP swap rate of 3.10%
for the first semiannual period. Six months later, Ace and its counterparty settle
the first swap payment, and no change has occurred in terms of future interest
rate expectations. Which of the following statements best describes the value of
the swap from Ace’s perspective?
A. Ace has an MTM gain on the swap, because once it makes the first known
net payment to its counterparty, the remainder of the future net fixed
versus floating cash flows must have a positive present value from Ace’s
perspective.

B. Ace has an MTM loss on the swap, because once it receives the first known
payment from its counterparty, the remainder of the future net fixed
versus floating cash flows must have a negative present value from Ace’s
perspective.

C. While the present value of fixed and future cash flows was set to zero by
solving for the swap rate at inception, we do not have enough information to
determine whether the swap currently has a positive or negative value from
Ace’s perspective following inception.

Isn’t it a loss for the fixed rate payer?

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[Madhu Chandarasekaran, CFAKeymaster]

Hi Aishwarya,

Thanks for the question. this is a tricky one.

You are correct to consider that paying the fixed rate (3.10%) and receiving the floating rate (initially 1.75%) would generally result i

Hi Aishwarya,

Thanks for the question. this is a tricky one.

You are correct to consider that paying the fixed rate (3.10%) and receiving the floating rate (initially 1.75%) would generally result in a loss for the fixed-rate payer, given the rates provided. However, the scenario described includes some nuances related to swap valuation and mark-to-market (MTM) calculations:

Key Details:

1. Swap Valuation at Inception: At inception, the present value of fixed and floating cash flows is set to zero when the swap rate (fixed rate) is determined.
2. After Six Months:
   • The fixed payment of 3.10% for the first semiannual period is known.
   • The floating payment for the first semiannual period is based on the GBP MRR of 1.75% at inception, which is also known.
   • No changes in future interest rate expectations means that the floating leg cash flows for subsequent periods are still expected to reset to the prevailing market swap rates.

Given that one negative value for ACE is taken out the remaining payments PV will have to be positive. So, The best answer is B:

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• This reply was modified 4 months ago by Madhu Chandarasekaran, CFA.

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