EOC Question 2B, for Reading 38 (Swaps) asks whether a 3 year swap or a 4 year swap should be preferred?
Your responses are much appreciated.
The current portfolio has duration 1.5. The objective is to increase the duration to 3.5. So, the duration should be increased by 2 from 1.5 to 3.5.
The correct answer according to me is that the 3 year swap should be preferred because the duration of 3 year swap is 2 as seen below.
Duration of 3 year semiannual payment swap = duration of Receive fixed - Duration of Pay Floating.
= (0.75 * 3) - (0.5 * 0.5) = 2.
Spot on.
Why does the book say that we should prefer 4 year swap, which increases the duration by 2.875.
Your responses are much appreciated.
P.
OK, sorry I should have waited till I read the response the Question 2C.
I guess, we prefer the 4 year swap because we can get away with less Notional principal as compared to a 3 year swap which would require more NP because of smaller duration.
Please correct me if I am wrong in my conclusion.
Regards
P
psriniva:
EOC Question 2B, for Reading 38 (Swaps) asks whether a 3 year swap or a 4 year swap should be preferred?
Your responses are much appreciated.
The current portfolio has duration 1.5. The objective is to increase the duration to 3.5. So, the duration should be increased by 2 from 1.5 to 3.5.
The correct answer according to me is that the 3 year swap should be preferred because the duration of 3 year swap is 2 as seen below.
Duration of 3 year semiannual payment swap = duration of Receive fixed - Duration of Pay Floating.
= (0.75 * 3) - (0.5 * 0.5) = 2.
Spot on.
Why does the book say that we should prefer 4 year swap, which increases the duration by 2.875.
Your responses are much appreciated.
P.
cpk123
April 6, 2012, 10:29pm
#4
anything lower would also require u to enter into the swap more # of times.
OK. Thank you both, Janakisri and CPK123.
CPK123 - You are saying more number of times, which in this particular instance translates to higher Notional Principal.
P
rahuls
April 7, 2012, 8:21am
#6
3 yr swap will have NP = $ 100 mi
4 yr swap will have NP = $69.56 mil
So 4 is preferred. I also did nt understand " anything lower would also require u to enter into the swap more # of times’?
cpk is correct . A 3 year hedge will need to be renewed because the desired duration is 3.5 . The 3 year bond will expire in 3 and you will need another bond thereafter.
Which means at least two transactions and transactions cost money ( commissions etc. )
rahuls
April 8, 2012, 5:43am
#8
So choice of swap will also be determined by its contract term. Should this alwyz be atleast equal or greater than the desired duration?
I thought it is determined by the Notional principal amount & net duration of the swap
