The PM’s BPV of Assets < BPV of Liabilities and she much hedge (protect against falling rates). She has three choices:
- 2.5% fixed-rate swap (No premium)
- 2.3% receiver swaption (75 bp premium)
- 3.3% payer swaption (75 bp premium)
The reading says if that a swaption collar is the best choice if she expects rates to be above 2.5% but below 3.3%. WHY?
This is from the reading:
The collar (buy the 2.3% receiver swaption and sell the 3.3% payer swaption) has no intrinsic value, which is the best choice.
- The right to receive 2.3% when rates are above 2.5% has no value.
- The payer swaption buyer has no rational reason to exercise his right with new SFRs below 3.3%.
I agree with the above that the collar has no value. So if the rates drop from 3.1% to 2.8%, the collar has no value but doesn’t that mean she effectively has no hedge and her liabilities will still go up more than her assets? How does the swaption collar help in this case?