Which of the following is the primary factor that determines the fixed and floating rates set at the time an interest rate swap is initiated?
A)Actual market rates that materialized over the life of the swap contract.
B)London interbank offer rate (LIBOR).
C)Upfront fee payments.
D)Market's expectations of future short-term rates.
E)Varying notional values underlying the swap.

Question

Quizplus · Accepted Answer

The primary factor that determines the fixed and floating rates set at the time an interest rate swap is initiated is the market's expectations of future short-term rates. The fixed rate is typically based on the expected future short-term interest rates while the floating rate is usually based on a benchmark rate such as the LIBOR. Actual market rates that materialize over the life of the swap contract may differ from the rates at the time of initiation, but the expectations of future rates are what determine the initial rates. Upfront fee payments and varying notional values underlying the swap may affect the overall value of the swap but do not determine the fixed and floating rates.

Which of the Following Is the Primary Factor That Determines