Chartered Financial Analyst (CFA) Practice Exam Level 2

In countries lacking a liquid government bond market, the SWAP curve serves as a critical benchmark for assessing the pricing of over 1-year securities. The SWAP curve is derived from the interest rates of interest rate swap agreements, which allow parties to exchange cash flows based on different interest rates. These agreements are typically tied to a notional principal amount and help gauge market expectations of future interest rates and credit risk.

The SWAP curve reflects the market's perceptions of risk and the prevailing economic conditions, including treasury rates and central bank policies. It is particularly useful in environments where government bonds do not provide a reliable indicator due to illiquidity or lack of issuance, offering investors a suitable reference for pricing debt instruments with maturities extending beyond one year.

In contrast, benchmarks like LIBOR, the yield curve, and the prime rate serve different purposes and may not reflect long-term securities effectively in a country with an underdeveloped bond market. LIBOR is primarily for shorter-term loans and may not provide an accurate long-term perspective. The yield curve, which is formed from government bonds, may not be available or reliable in such markets. The prime rate is generally applicable to lending rates set by banks and does not specifically relate to the broader fixed income market.