Swaption Collar (How does it contribute to portfolio value?)

CFA Level III
#1

Using Swaption Collar to improve portfolio BPV seems a little unclear from oth Schweser and Wiley.

W all know that when interest rate is projected to decline, asset BPV will increase less than liability BPV, thus asset BPV underperform Liability BSP, thus we go into a contract to receive the fixed rate in a Swap agreement or simply buy Receiver Swaption.

However, can someone help clarify step by step how Swaption Collar adds value to the portfolio BPV when interest rate is projected to increase?

This is my view. When interest rate is projected to increase, Asset BPV decline less than Liability BPV, so asset BPV outperform Liability BSV, thus we need to reduce our hedge position. Thus buying Receiver Swaption and writing Payer Swaption will only lead to the fund manager receiving the fixed payment from both transaction.

Assume the initial Receiver Swaption is followed by Buying another Payer Swaption when interest rate is expected to increase, then this make sence because the manager is trying to reduce his hedge position.

So, please do make it clear how Swaption Collar contribute to portfolio value.

Thanks.

#2

This is true if the (effective) duration of the assets is shorter than that of the liabilities, but not if it’s longer.

What makes you think that the duration of assets must needs be shorter than that of the liabilities?

#3

Magician, For most pension funds, they hold larger percentage of their asset in equity which have lower effective duration and consequently the overall asset duration is mostly lower than the liability duration.

Can you please help me out on how Swaption improves Asset BPV when interest rate is expected to increase.

Thank you.