CFA Level IDerivativesMedium
Two counterparties enter a $10 million notional interest rate swap with annual settlement. Party A pays a fixed rate of 4.0% and receives a floating rate that resets annually. At the first settlement date, the floating rate that was set at initiation is 3.5%. What is the net cash flow for Party A at this settlement date?
- AParty A pays $350,000
- BParty A pays $50,000
- CParty A receives $50,000
- DParty A pays $400,000
Show answer & explanationAnswer & explanation
Correct answer: B. Party A pays $50,000
Party A pays fixed (4.0% × $10M = $400,000) and receives floating (3.5% × $10M = $350,000). The net cash flow is calculated as the difference: since fixed exceeds floating, Party A makes a net payment of $400,000 - $350,000 = $50,000.
Why the other options are wrong
- A. This is the floating leg amount alone, not the net cash flow.
- C. This reverses the direction of payment; the fixed-rate payer pays, not receives, in this scenario.
- D. This is the fixed leg amount alone, not the net settlement amount.
Interest Rate Swap Net Settlement
In a plain vanilla interest rate swap, only the net difference between the fixed and floating payments is exchanged at each settlement date.
- Net payment = (Fixed rate - Floating rate) × Notional
- Fixed-rate payer pays when fixed > floating
- Only the net amount is exchanged, not gross payments
Memory trick: Swap streams net out — only the difference crosses the table.