Chartered Financial Analyst (CFA) Practice Exam Level 2

What does the SWAP spread refer to?

1. The difference between fixed rates of various currencies

2. The difference between SWAP fixed rate and government bond of similar maturity

3. The difference between SWAP rates in different markets

4. The difference between floating rates and fixed rates

The correct answer is: The difference between SWAP fixed rate and government bond of similar maturity

The SWAP spread is defined as the difference between the fixed rate of a swap and the yield of a government bond with a similar maturity. This spread serves as a measure of the compensation investors require to enter into a swap agreement as opposed to investing in a risk-free government bond. It reflects various factors, including credit risk, liquidity, and the overall economic environment. When comparing a swap's fixed rate to a government bond yield, it highlights the relative value and perceived risk of entering into the swap contract. A wider spread may indicate higher perceived risk associated with the counterparty or market conditions, while a narrower spread suggests that the swap is priced more favorably compared to government securities. Other options do not correctly represent the SWAP spread definition. For instance, the first option refers to currency rates rather than the fixed rate comparison involved in swaps. The third option talks about different markets, which does not align with the concept of a spread that focuses on rates of similar instruments. The fourth option indicates the relationship between floating and fixed rates, but it lacks the specific context of comparing these rates against a benchmark like a government bond yield.