Chartered Financial Analyst (CFA) Practice Exam Level 2

What is the formula for calculating the value of a SWAP?

1. SFR = (1 - Z4) / (Z1 + Z2 + Z3 + Z4)

2. SFR = (Z1 + Z2 + Z3) / (1 + r(n))

3. SFR = Z1 x Z2 x Z3 x Z4

4. SFR = (1 + r(n)) x (Z1 + Z2 + Z3 + Z4)

The correct answer is: SFR = (1 - Z4) / (Z1 + Z2 + Z3 + Z4)

The formula for calculating the value of a swap often relates to the present value of cash flows, where "SFR" denotes the swap rate factor in this context. In the correct choice, the formula states that the swap rate factor is equal to the difference in present values of the fixed versus floating legs of the swap. The reason this formula is correct is that it takes into account the present value of future cash flows associated with the swap. The term (1 - Z4) refers to the present value of cash flows paid in the future, while the denominator (Z1 + Z2 + Z3 + Z4) represents the total present value of cash flows from both parties to the swap. This ratio effectively assesses the value of the swap by determining the net present value generated from the difference between these cash flows. When analyzing options that may seem plausible, such as the other choices presented, it's clear they do not accurately represent the dynamics of calculating swap values or the present value framework. Each alternative introduces elements that do not conform to the standard methodology used in swap valuation, focusing on aspects that either aggregate irrelevant components or misrepresent the cash flow relationships involved. By focusing on the net present value calculated in option A, it illustrates a key principle in