Hi,
This question asks us what the notional principal of a swap should be to achieve the desired duration. Since the question asks us to achieve a target duration of 3 but gives us 3 different swaps (3-4-5 years).
The question uses the swap maturity of year 5 without providing an explanation. Is the reason that they use year 5 due to the fact that the original duration of the fixed income portfolio has a duration of 5?
Thank you for those who are able to clarify!
biggest duration has the smallest size of the NP.
But interest rate swap doesn’t require exchange of notional principal compared to currency swap right? So why must we pick swap C, instead of swap A which give us answer C? Thank you so much.
if you used a smaller duration swap - you need to invest in the swap so many more times (roll it over on expiry).
while with a larger duration swap - you achieve your cash flow swap needs, without having to roll over the swap so many more times.
Is the reason that they use year 5 due to the fact that the original duration of the fixed income portfolio has a duration of 5?
Yes.
Check the errata they admit to screwing this one up I believe
errata related only to the fact that there were two correct answers before - which they fixed now.
you still need to pick the highest duration swap to get the right notional amount.
cpk - why do you need the highest duration swap?
answered above…
so you do not have to roll over multiple times… with the highest duration - your notional principal would be small - and additionally you would be matching the duration of the liability as well.
if you used a smaller duration swap - you need to invest in the swap so many more times (roll it over on expiry). while with a larger duration swap - you achieve your cash flow swap needs, without having to roll over the swap so many more times.
ALLWAYS pick the swap with the highest duration if you want to increase the portfolio duration or lowest one if you want to decrease it
ok thanks guys