False Statements about Interest Rate Swaps

D

The correct answer is D. Notional principal is exchanged at initiation and termination while only net interest rate payments are exchanged on the settlement dates.

An interest rate swap is a financial contract between two parties who agree to exchange interest rate payments based on a notional principal amount. The purpose of an interest rate swap is to manage or hedge interest rate risk.

Let's go through each statement and explain why D is the false statement:

A. The parties agreeing to swap cash flows are called the counter parties. This statement is true. In an interest rate swap, there are two parties involved, commonly referred to as counter parties. These parties agree to exchange cash flows based on the terms of the swap agreement.

B. Swap facilitators are the people who bring the counter parties together. This statement is true. Swap facilitators, such as investment banks or brokers, play a role in bringing the counter parties together and assisting in the negotiation and execution of the interest rate swap contract.

C. A plain vanilla interest rate swap is a fixed rate for variable rate swap. The variable rate is usually set at LIBOR flat. The period of time involved in the swap is called the tenor. This statement is true. A plain vanilla interest rate swap involves the exchange of fixed-rate payments for variable-rate payments. The variable rate is often linked to a benchmark rate such as LIBOR (London Interbank Offered Rate). The period of time involved in the swap, from the initiation to the termination, is referred to as the tenor.

D. Notional principal is exchanged at initiation and termination while only net interest rate payments are exchanged on the settlement dates. This statement is false. In an interest rate swap, the notional principal amount is not exchanged at initiation or termination. The notional principal amount is used to calculate the interest payments but is not physically exchanged. Instead, only the net interest rate payments, which are the difference between the fixed and variable rate payments, are exchanged on the settlement dates agreed upon in the swap contract.

Therefore, the false statement is D. Notional principal is exchanged at initiation and termination while only net interest rate payments are exchanged on the settlement dates.