Which of the following is equivalent to a pay-fixed interest rate swap? A) Buying a cap and selling a floor. B) Buying a cap and selling an interest rate collar. C) Selling a cap and buying a floor. I can’t get my head around this…Can anyone enlighten me? The official answer is B
Pay fixed side of swap will benefit only if LIBOR goes up and loose if LIBOR goes down ( as it is receiving floating) From the options A) Buying a cap and selling a floor ----- Interest rate goes up, benefit comes from cap. But if interest rate goes down, there is benefit again from floor… NOT SIMILAR TO SWAP B) Buying a cap and selling an interest rate collar— Interest rate goes up, benefit comes from cap. If interest rate goes down, it might loose because of floor in the collar C) Selling a cap and buying a floor. -----OPPOSITE OF A This is what I think
but for A if you are SELLING a floor you don’t get any benefit from the floor… it hurts you. so i thought it was A… if rates go up the cap helps you, if rates go down the floor you sold hurts you
Mike0021, I think you are correct. In that case I do not know how the answer could be B
Ops my bad Your answer: B was incorrect. The correct answer was A) Buying a cap and selling a floor. A pay-fixed interest rate swap has the same payoffs as a long position in the corresponding interest rate collar (with the strike rate equal to the swap fixed rate).
I can’t see it yet, but let’s try to work it out. B) Buying a cap and selling an interest rate collar. In a pay fixed swap you are: 1. Paying a fixed rate 2. Receiving a floating rate Broken into components (trying to replicate above payouts^) 1. Long a cap - Pays off if interest rates rise about strike rate Sell IR collar - 1. Short a cap (series of IR calls)- will have to payout if interest rates rise about strike rate (this should cancel the long cap) 2. Long a floor (series of IR puts) - this will pay if interest rates drop below the strike rate. Still can’t quite see it. Does this help anybody else?
Corrupted Wrote: ------------------------------------------------------- > Ops my bad > > Your answer: B was incorrect. The correct answer > was A) Buying a cap and selling a floor. > > A pay-fixed interest rate swap has the same > payoffs as a long position in the corresponding > interest rate collar (with the strike rate equal > to the swap fixed rate). Pay fixed swap (rec float). You win if interest rates go up, you lose if interset rates go down (as determined by value of swap at any one point in time with 0 value at initiation). Long cap - pays off if interest rates rise above strike rate (just like pay fixed) Short floor - you have to pay if interest rates drop below strike price. (Just like pay fixed)
max(s-x,0)-(max(s-x,0)-max(x-s,0)) = max(x-s,0) for B, so no swap for A, max(s-x,0)-max(x-s,0). s>x, we have s-x, so pay fixed. s