The swap rate offered by swap dealers must align with the forward rates in the BAB futures market, since a strip of forwards could serve the same purpose as a swap.

Question

Quizplus · Accepted Answer

The assertion is true because the forward rate in the BAB futures market represents the expected rate of borrowing or investment for a future period. Similarly, the swap rate typically represents the rate of borrowing or investment for the same period. If the swap rate offered by dealers deviated significantly from the corresponding forward rate, an arbitrage opportunity would arise, whereby investors could borrow at the cheaper rate and invest at the higher rate. This would cause the two rates to converge eventually. Additionally, a strip of forwards could be used to synthetically create a fixed-floating rate swap or vice versa, supposing no arbitrage opportunities exist.

The Swap Rate Offered by Swap Dealers Must Align with the Forward