Hello,
For a receiver swap (i.e. receive fixed pay floating), would it increase an asset duration and ALSO reduce a liability duration?
While we’re here, can someone remind me about swaptions and convexity? does selling both receiver and payer swaptions reduces convexity? whats the intuition behind this?
Regarding the first, I would assume it will only affect the asset side. Normally you would have the liabilities given and adjust the portfolio, i.e. the assets accordingly.
In any way, you will normally be focused on (increasing or decreasing) the duration gap which is the difference between asset and liability duration so that it does not really matter where the swap will be accounted for.
When you enter into a swap as the fixed rate receiver, you receive the fixed payment which have higher duration compared to the floating rate payment you paid to the counter party (which have lower duration).
Due to the higher duration of the fixed payment received, the asset duration is improved.
This has nothing to do with the liability duration.
So, receiving fixed rate improves asset duration which improves the overall portfolio duration.
Receiver swaption is a right to enter into a swap in the future. So, until the option is exercised, receiver swaption has no value to the portfolio duration. It adds value only when it is exercised and it add more duration to the asset side when decrease (when rate decreases, for pension fund and insurance that invest larger portion of their fund in equities (equities have lower duration), their asset will increase less than the increase in duration when interest rate falls, thus exercising a receiver swaption will improve the asset and the overall portfolio duration).
Hope that helps.
Thanks all!
So lets say i’ve just issued floating rate notes and enter into a payer swap (i.e. receive float, pay fix). Have i increased or decreased my duration?
Schweser exam 2 suggests that i have increased my liability duration…
They are talking about an issuer and that issuer’s liability in your example. Its the same question as usual but from the issuer’s perspective as opposed to from the portfolio manager’s.
Issue FRN: pay float (low duration liability) Payer swap: pay fix, receive float (high duration liability, low duration asset)
The issuer has increased their liability duration.
For a portfolio manager:
PM buys FRN: receive float (low duration asset) PM enters receiver swap: receive fixed, pay float (low duration liability, high duration asset)
receiver swap cancels out FRN float income and turns it into fixed, increasing asset duration.
I don’t know the exact context of your question so apologies if I overlooked something, but generally speaking the floating leg of a swap is treated as having duration 0 (that’s technically not true, the true duration is time to the next reset since the floating leg fixes in advance). So the duration on the swap will be almost entirely the duration of the fixed leg.
So would definitely increase your asset duration. But from an asset-liability perspective, I’ve never known anyone that considers the floating leg to reduce liability duration.
Regarding swaptions, yes swaptions have convexity. In fact, buying or selling ATM swaption straddles is a common way in the market to buy or sell convexity without distorting your portfolio duration.
I’m not sure what intuition you’re looking for here…intuition behind why swaptions have convexity? Or why buying/selling swaptions amounts to buying/selling convexity?
I would agree with the Schweser. Based on my last answer, if you enter into a payer swap, you’ve done nothing to your asset duration but you have increased your liability duration (the fixed payments are now an additional liability).
That said, I can totally see if you would want to argue that you’ve reduced asset duration by entering into the payer swap, since that’s how a lot of market participants will choose to view it.
This was the answer i was looking for. So generally we cant say “receiver swaps increase duration” because we need to know from which perspective?
If you are long the receiver swaption, you are technically increasing asset duration, but if you are short payer swaption (issuing payer swaption), you are paying the fixed rate and receiving the floating rate, thereby increasing liability duration at the expense of asset.
So, yes, you need to from which perspective the swaption transaction is taking place.
Not sure I am following, you say:
Long receiver swaption = Increase asset duration (Ok you pay float and receive fixe)
Short payer swaption = Increase liab duration (Why? here you’d be obligated to be the opposite party of a long payer swaption hence you you would have to receive fixe and pay float - so you also increase asset duration)