Liability Driven Investing- Using Swaption Collar

Buying receiver swaption is synonymous to being long in an interest rate swap.

However, I am having issues wrapping my head around Swaption Collar which entainl the combination of buying the Receiver Swaption and at the sametime selling a Payer Swaption. The client pays a premium in order to receive fixed payment (receiver swaption) and receives a premium in order to pay the fixed payment (to the payer Swaption buyer).

The net effect of this strategy is zero, as the receiver swaption and payer swaption offset each other, but the initial reason for receiver swaption is to immunize the portfolio duration gap.

So, technically, this swaption collar does not necessarily improve the portfolio duration, or does it?, because what you receiver, you pay it out back to another person.

Please I need your insight.

You mean a payer swap? Not familiar with being long a swap.

It does improve!

LDI is all about hedging, your liabilities increase as yields go down (Y% down P% go up=> BAD for debt right?) this causes duration gap which a reasonable thinking manager needs to tackle. Your Swaption Colar is zerocost. both premium received and price paid offset each other but… it is still hedging

You need to look at this in the context of the defined benefit plan because many decisions are led by LDI, so funded status of the plan Assets- PBO. Collar you mentioned gives you protection when yields are falling (thus plan liabilities are rising which is bad for the plan), and gap is increasing which is bad too, your goal is though to decrease the gap (A-L) so this structure you talking about delivers value to the assets in case of falling yields which decreases the gap. Also remember that Receiver Swaption can generate immediate gain (increase in value of the option) in case of falling yields.

Yea, I understand you.

I understand how it adds value to portfolio BPV now.

Collar involve Buying Receiver Swaption (Receiving the Fixed Rate when the Swap Market Rate is expected to decline, and paying the Floating Rate) and Selling Payer Swaption (Paying the Floating Rate and Receiving the Fixed Rate), thus both position will increase portfolio BPV.

Now it is clear, I missed the interpretation of Collar legs before. Its clear now… Thanks.