How do you value an interest rate swap that is already partway through its life?

Valuing an interest rate swap mid-life is one of the most testable skills in FRM Part I. The key insight is that a swap can be decomposed into two legs, and you value each leg separately using current market discount factors.

Two Equivalent Approaches

Approach 1 — Bond Portfolio Method

The fixed-rate payer is effectively long a floating-rate bond and short a fixed-rate bond. At any point in time:

V_swap (fixed payer) = B_float - B_fixed

Where B_float is the value of the floating-rate bond and B_fixed is the value of the fixed-rate bond.

Approach 2 — Forward Rate Agreement (FRA) Method

Each remaining exchange is treated as a separate FRA. You compute the expected floating payment using forward rates, net it against the fixed payment, and discount each net cash flow back to today.

Worked Example

Suppose Meridian Capital entered a 3-year swap 1 year ago as the fixed-rate payer at 4.20% on a $50 million notional. Payments are annual. Today's LIBOR term structure is:

The last floating reset was at 4.10%.

Step 1 — Value the fixed leg:

Remaining fixed payments: $50M x 4.20% = $2.1M at year 1, and $2.1M + $50M = $52.1M at year 2.

B_fixed = 2.1 / 1.045 + 52.1 / 1.048^2 = 2.0096 + 47.4071 = $49.4167M

Step 2 — Value the floating leg:

The floating bond resets to par at the next payment date, so:

B_float = (50 + 50 x 0.041) / 1.045 = 52.05 / 1.045 = $49.8086M

Step 3 — Swap value:

V_swap = 49.8086 - 49.4167 = +$0.3919M (positive for fixed payer, since rates rose)

Key exam traps:

1. The floating leg does NOT reset to par today — it resets to par at the next payment date, so you must discount back one period at the current spot rate.
2. If you are the fixed receiver, the sign flips: V = B_fixed - B_float.
3. Always include the notional principal in the final cash flow of each leg.

For more swap valuation practice, explore our FRM Part I question bank.