2. An interest rate swap with notional value of 100m has a remaining life of 9 months. The terms of the swap require the 6-month LIBOR to be exchanged for 5.5% per annum with semi-annual compounding. The current swap rate being exchanged for LIBOR in swaps of all maturities is 4.75% per annum with continuous compounding. Three months ago the 6-month LIBOR was 5.25% per annum.

Discuss the principle that underpins swap valuation. (30 marks)