B makes perfect sense to me, honestly. I didn’t read through all the different arguments people made, but receive fixed/pay floating increases the duration of the firm. If interest rates go up, the firm is subject to more MV risk and less cash flow risk. Receive fixed = higher duration = more MV risk, less CF risk Receive floating = lower duration = more CF risk, less MV risk
Skillionaire, not sure if that is correct. Ok, now that I’m awake and reread the garbage I posted (sorry people)…Just pointing out, there is a discrepancy in the swap in the original post vs the one from Vol 2, Exam 2 PM #20.6. The answer is B if he used a “pay fixed/receive floating swap” like #20.6, but the answer is still C in reference to the original post that used a “pay floating/receive fixed swap” The question in vol 2 specifically says he has a FRN that he is trying to hedge with a pay fixed/receive floating swap. If interest rate goes up: 1) the floating receipt cancels out with floating pmt, so he locks in a fixed pmt = decreased CF risk 2) the duration of the liability with the swap is now higher (turned floating liability to fixed), therefore more MV risk. The original post asks for a “pay floating/receive fixed swap” which is opposite of #20.6 1) the fixed pmts cancels out, and the new floating pmt exposes you to increase CF risk 2) duration of the liability decreases (because it is now a floating liability), therefore decreased MV risk.
stupid question. FinanceMBA tried to frame this question from different question and now couldn’t (i guess) provide the right answer
I think the best way for these problems is to look at them from what you end up paying because your swap receipt cancels out with whatever the original payments were. So: if you are pay fixed swap: no CF risk, higher MV risk if you are pay floating swap: higher CF risk, lower MV risk
100% agree with shanghai on this.