Using swaps to adjust duration, how do we know which to select given the choice between two swaps? Do we usually want the one with the largest duration to lower the notional principal required?
They both work and the notional principal will be different. Usually it will give a constraint like, manager wants to choose the swap that has a notional principle closest to his portfolio. I think there is a practice question or exam that says that.
edit - it duplicated my response again.
In question 2 reading 38, the first bond’s duration is 2.
Would that not raise duration with a notional of 100m?
.75*(3)-.25=2.0 Duration of swap
Or does that not raise duration at all, since its 1?
And back to my original question, if they just said “which should you choose” in a general question, not this one, with no constraints, how would one choose?
1 = the ratio right?
You are still extending duratiuon to 3.5 by using 1*Valuetobe hedged. Its just a 1 to 1 relationship between portfolio and NOtional principle.
Going back to your original question,in the absence of constraints (mgr wants lowest NP, similar NP to portfolio, etc) I think I would use the one that is closest in notional principle first, then frequency of payments second as my tie breakers… but thats just a guess and I don’t remember the material providing a clue on this one.
Maybe it has to do with where your duration exposure is in your current portfolio. If its a bullet, use one with closest duration/NP. Or possibly it could depend on view of term structure of rates becuase rates might not shift in a parallell fashion.
Does anybody else know if there is a preference/guidance here?
This question has already been answered twice within the last two months in this forum. Please search by the reading number.
I think Janakisri and CPK123 both answered this question.
If there are no additional constraints, you should choose the one with the lower NP.
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