BOND MATH: The Theory Behind the Formulas

Valuing an Interest Rate Swap

Pricing a swap is the determination of the fixed rate at origination; valuing the swap is determining its fair value thereafter. A plain vanilla swap starts with an initial value of zero because by construction the present values of the fixed-rate leg and the floating-rate leg are equal. As time passes and as interest rates change, the swap takes on positive or negative value. That's important because accounting rules for derivatives require that the fair value of the swap be recognized on the balance sheet as an asset or liability. Moreover, depending on the applicability of hedge accounting treatment, the change in fair value from period to period might have to flow through the income statement. That can impact ...