Chartered Financial Analyst (CFA) Practice Exam Level 2

What is the main characteristic of a Payer Swap?

1. Pay Fixed, Receive Floating

2. Receive Fixed, Pay Floating

3. Pay Variable, Receive Fixed

4. Receive Variable, Pay Fixed

The correct answer is: Pay Fixed, Receive Floating

A Payer Swap is defined primarily by its structure, where one party agrees to pay a fixed interest rate while receiving a floating interest rate. This arrangement is generally utilized by entities that wish to hedge against rising interest rates or lock in a fixed rate for financial planning purposes. The fixed payments provide predictability in cash flows, while the floating rate allows for potential benefit if interest rates decrease. This characteristic highlights the different motivations behind entering such swaps. For example, a company expecting to pay less in the future on its floating-rate debt might prefer to stabilize its payments through a fixed rate in a Payer Swap arrangement. By paying fixed and receiving floating, the party effectively takes on the risk associated with fluctuations in interest rates, which can be a strategic financial management move. Understanding this foundational structure of a Payer Swap is crucial for evaluating its impact on overall portfolio and risk management strategies in the context of interest rate changes and potential market conditions.