Pricing and Valuation of Interest Rate and Other Swaps — MCQs

Meridian Capital manages a diversified multi-asset fund and uses derivatives both to obtain market exposure and to alter the fund's interest-rate profile. The derivatives committee requires all positions to be priced using no-arbitrage relationships and values to be reported from the fund's perspective. Unless stated otherwise, quoted rates are annual rates, and there are no transaction costs, taxes, or restrictions on short selling. An analyst first considers establishing a six-month long forward on a broad equity index. The index pays dividends continuously, so the analyst treats the dividend yield as an economic benefit forgone by holding the forward instead of the underlying index portfolio. The analyst notes that a forward's delivery price is set so that the contract has zero value at initiation, but its value can subsequently become positive or negative as market conditions change. The fund already holds a long equity index forward with a delivery price of 2,480 and three months remaining. To value this contract, the analyst obtains current spot, financing-rate, and dividend-yield data. The counterparty has posted collateral, but the contract is not settled daily. The analyst is instructed to calculate the current value rather than the current forward price or the expiration payoff. Meridian also holds a receive-fixed, pay-floating interest rate swap with a semiannual settlement convention. The floating payment for each period is determined using six-month SOFR observed at the beginning of that period and is paid at the end. The fixed and floating amounts are netted at settlement. The most recent SOFR reset has already occurred, making the next floating payment known even though later payments remain uncertain. Finally, the committee is comparing OTC forwards with exchange-traded futures. One member states that identical forward and futures prices are not guaranteed when interest rates are stochastic because futures gains and losses are realised daily and can be reinvested or financed at prevailing rates. For the operational comparison, the committee focuses on the daily settlement mechanism rather than on potential price differences arising from the correlation between interest rates and the underlying asset.