# Need help w/example in CFAI text

Volume 5, page 235, example 2 Can someone please explain why they only discount the floating payments for two months yet they discount the fixed payments for two and eight months? And, how can the value be positive to fixed payer when they are the ones paying 7% and receiving 6.9%? I’m so f-ing confused on this. PS It’s not in the errata.

jennygirl Wrote: ------------------------------------------------------- > Volume 5, page 235, example 2 > > Can someone please explain why they only discount > the floating payments for two months yet they > discount the fixed payments for two and eight > months? All fixed payments are discounted in order to find to find the PV of fixed rate side of the swap. The return of principal is also accounted for with the final fixed payment. On the floating side, you only have to consider one payment since the rate is reset to current market rates on the next payment date. Think of it like a floating rate bond which is priced at par when the rate is set for the next period. They are discounting it for 2 months because that’s the amount of time until the next payment. The fixed rate loan has another set payment which will occur 6 months after that. > > And, how can the value be positive to fixed payer > when they are the ones paying 7% and receiving > 6.9%? > The NEXT floating rate payment is @ 6.9%, but the yield curve is upward sloping (you could find that the 6 month forward rate 6 months from now is actually 7.5%) so the market currently expects that the rate will reset to 7.5% once the next floating rate payment is made (if you believe in pure expectations theory). If you price the floating rate bond like a fixed rate bond with 1st pmt @ 6.9%, and the second pmt @ 7.5% you will get the same price for the floating rate side. But, since we know that the floating rate resets at the next payment date, accounting for the expected future payments isn’t necessary. > I’m so f-ing confused on this. > > PS It’s not in the errata.

What he said ^

Thanks. You guys are awesome.