Can someone please explain how these increase or decrease in swaps?
If I am PAY FIXED, RECEIVE FLOAT
I understand that the cashflow risk falls, as I have a fixed payment
But what happens to market risk and price risk?
Market risk increases
Price risk - I am unsure.
As for the explanation, even I’d like to know.
Right.
Pay Fix has a higher duration than floating, so the market value is more subject to changes in interest rates (like the price of bonds). --> increased market risk
what do you mean with price risk?
It all depends on the rest of your portfolio.
Seriously.
It was from a BPP mock exam - it used price risk.
So, Pay fixed = low cash flow risk but HIGHER market value risk? I can so see this as an MCQ I just want to make sure I have it nailed on.
Pay fixed / receive floating and pay floating / receive fixed, by themselves, have exactly the same cash flow risk as each other and exactly the same market value risk as each other.
The curriculum does mention that with using a paying fixed receive floating to hedge a current floating obligation you lower your cash flow risk (can budget for the payments) but it increases your market value risk (interest rate changes). Replacing a fixed obligation with a received fixed pay floating lowers your market value risk but increases your cash flow risk (can’t budget for the payment). I think this might be what magician is getting at
Aha!
It might just be:
price risk should be equal to market value risk?
because floater’s price should be always near par value while fixed instruments’ price will be the one to fluctuate when yield changes.