CFAI 2008 AM actual, question 8 guideline answer: The PV(fixed-leg) = ((1+(0.055*(180/360)*0.9911)+ ((1+(0.055*(180/360)))*0.9649)=1.0187 WTF? Even if you follow their brackets you get to the answer 2.0187. I also dont understand why do they add principal amount (1) to payments to come to PV of payments. Payment should be based on the difference in interest rates, there is no principal exchange so why add principal to PV??? Explanation in guidelines (for floating rate only, but still): “The PV of floating-leg equals 1 (the notional principal) plus the next floating payment discounted by the 2-month factor.” The disturbing thing now is that it’s not Schweser, it’s CFAI and real exam guideline answers which graders probably use…
Yes, disturbing. However, this question was such that the fixed rate was meaningfully higher than the current Libor so in actuality you really didn’t even need to do these calculations if one understands the structure of these things. At least that is my view.
Is it not appropriate to just use the next payment and say the counterparty currently bears the credit risk becase the 5.5% fixed RR will pay exceeds the 5.4% float RR will receive?
^Yeah, thats what i did. They just ask us for one reason anyways and surely theres no time for you to do the whole calculation for all the payments. gave myself full credit.
I struggled with this for an hour at least. Never got a resolution. Should you just add the 1 to the 2nd payment? I didn’t try that.
^ yes. i think the answer key has an error on it. example 8 on pages 235-236 v5 CFAI text only show adding the 1 on the last fixed payment. Isnt this supposed to represent the return of the principal?
eriqnoodle, thanks for the page reference!!
np. honestly, i had no freakin clue how to value swaps (brain dump) so i was just refreshing my memory.
I didn’t do any calculations. I saw that the fixed rate (5.5%) was higher than any other rate given, so I said they owe the counterparty money (and the counterparty bears the credit risk).