Interest Rate Swap Clarity for Assets vs Liabilities

Fellas, I need some clarity on Interest Rate Swaps:

  1. You own a bond portfolio (assets) and fear that interest rates may go up. So, you enter into an interest rate swap as as fixed rate payer (receive floating) which reduces the duration of the bond portfolio and hence the interest rate sensitivity.

  2. You own a variable rate loan (liability) and fear that the interest rates may go up. So, you enter into an interest rate swap as a fixed rate payer (receive floating). What is the impact on the duration and interest rate sensitivity on overall position? Will the duration reduce like the scenario 1? If not, why?

Thanks

In scenario 1, you are long duration; the pay fixed / receive floating swap has negative duration, so you reduce your duration (unless the duration on the swap is whacking big (i.e., more than twice the negative of your original duration)).

In scenario 2, you have essentially zero duration; the pay fixed / receive floating swap has negative duration, so you increase your (negative) duration, you don’t reduce it.

If you “own” a variable rate loan (i.e. you must make variable rate payments on borrowed funds), and you enter a pay fixed swap, the duration of your position will increase. The floating rate portion will net itself out, and you will be left with fixed rate payments. The duration of a pay-fixed position is

D(float) - D(fixed) which is < 0, which in absolute terms means the duration of your position has increased.

hope this helps…