page 225 book4, second paragraph. A manager enters a pay fixed /receive floating swap to change nature of a floating rate liability. “Since fixed rate instruments have a longer duration than floating rate instruments, the addition of the swap has increased the duration of the firms liabilities and narrowed the difference between the asset and liability durations”. Don’t they mean DECREASED the duration of the firms liabilities? adding the swap should decrease the duration of the liabilities no?
Recall the fixed rate instrument has a higher duration that floating rate swap. So by swapping into a fixed rate liability wih a higher duration, effectively the firm has increased the duration of the firm’s liabilities and shorten the duration of the equity and so the firm is less sensitive to i/r movement than before they enter into the swap.
pmoonoi, Can I find any relevant statement in CFAI’s text ?
Same issue in 2009 Schweser Practice Exam Book2 Exam 3 Q21.2. I don’t get it.
iregula Wrote: ------------------------------------------------------- > page 225 book4, second paragraph. > > A manager enters a pay fixed /receive floating > swap to change nature of a floating rate > liability. > > “Since fixed rate instruments have a longer > duration than floating rate instruments, the > addition of the swap has increased the duration of > the firms liabilities and narrowed the difference > between the asset and liability durations”. > > > Don’t they mean DECREASED the duration of the > firms liabilities? adding the swap should decrease > the duration of the liabilities no? I had to say it slowly out loud a couple of times to wrap my head around it, but I do believe that Schweser is correct. To decrease the duration you’d exit a pay fixed and get into a pay floating.
It seems that this issue is related to Cash Flow Risk & Market Value Risk. But the statements in Schweser note are quite different from that in CFAI’s text. I am confused too.
I think that maybe you guys are confusing “net duration” with the “duration of your liabilities”. In the example above, your “net duration” (duration of assets - duration of liabilities) would decrease, but the “duration of your liabilities” would increase.
skillionaire, I can not find similar statements in CFAI text (R43), only Cash Flow Risk & Market Value Risk are stated on P.484 of V5.
AMC Wrote: ------------------------------------------------------- > skillionaire, > > I can not find similar statements in CFAI text > (R43), only Cash Flow Risk & Market Value Risk > are stated on P.484 of V5. I’m not real sure what you’re asking, in all honesty. And as far as the CFAI text goes, I only do some random EOC questions - I use Schweser as my main source, so I’m not the person to ask for text questions.
Skill is correct because this statement refers to the company’s liabilities rather than its assets. While the swap in and of itself has a negative net duration, the swap allows the company to shift it’s liability into a fixed rate liability, which effectively means that the duration of its liabilities increases. You have to put the swap into the context of what the question is asking. If the question were discussing the manager’s use of the swap in the context of a portfolio of fixed income assets, the swap would effectively lower the manager’s asset duration.