Schweser practice exam question - exam book 1 mock exam 2 afternoon session

exam book 1, exam 2, pg 127, q 118

Based on a 30mm notional, and assuming that the value of the fixed-rate bond and floating-rate note are 0.99 and 1.01 (per $1 of notional principal), respectively, what is the payment required to terminate the swap, and which party will make the payment?

a. 600k paid by the floating rate payer

b. 1.2mm paid by the fixed rate payer

c. 600k paid by the floating rate payer, and 1.2mm paid by the fixed rate payer

answer is A.

i am having a hard time figuring out how to sync this up with my understanding. To me, it seems as if the floating rate note is worth more than the fixed rate note. Hence, if the fixed rate payer wanted to unwind, the fixed rate payer would have to pay the floating rate counterpart. the amount he would have to be would be 1.01 - 0.99 multiplied by 30mm trade notional, = 600k.

however, the answer suggests it is the exact opposite, that the floating rate payer would have to pay.

anyone have any thoughts or insights onto this?

thanks

michael

Hi,

I think all you need to do is to compare values of the swap for both counterparties. If you pay fixed rate and receive floating rate: 1.01*30 - 0.99*30= +0.6. If you receive fixed rate and pay floating rate : 0.99*30 - 1.01*30= -0.6. As you can see, value for floating rate payer is negative and, therefore, he would have to pay 600k the other counterparty to terminate the swap. I hope I`m correct and this helps you.