Credit Risk of Swaps

CFA Level III Derivatives
#1

On pg 177 of the CFAI text under Credit Risk of Swaps, a problem is presented that states that we are looking a plain vanilla interest rate swap with a one year life and quarterly payments at Libor. Using term structure, swap has a fixed rate of 3.68%, leading to quarterly fixed payments of $0.0092 per $1 notional principal. Moving forward 60 days into life of swap, a new term structure determines that the swap’s market value is $0.0047 per $1 notional principal. The text states that to the party that is long (paying fixed, receiving floating) swap has a positive market value and potential credit risk is assumed. However, as the market value after 60 days reflects a lower value per $1 of principal then the initial fixed payment, isn’t the long position (paying fixed, receiving floating) paying out more than the market-based floating payments? As such, wouldn’t the short position have the positive value and be assuming the potential credit risk?

Thanks in advance for your feedback.

#2

After a second look, it appears I am comparing two different values. The swap’s market value to the long indicates that the amounts owed to the party exceed the payments the party owes, a sign of positive value and thus the potential credit risk. Is this correct?

#3

Yes.

The value is the _ net _ value, which is zero at inception.