CFAI book 5 page # 530: B. Would you prefer 4 year swap with quarterly payments or 3 year swap with semiannual payments? In this problem, manager wants to increase the duration of portfolio from 1.5 to 3.5. I figured that target duration of swap we need is 2 years. Now, my calculations were : for 4 year swap, the duration will be 4(.75) - .125 = 2.875 for 3 year swap, it would be 3(.75) - .25 = 2 I picked 3 year swap because it has the duration of 2 which we want to add to our portfolio. Now, the answer key just mentions that 4 year swap wouyld be added because it has bigger duration. Can anybody explain where I’m going wrong here?
Manager wants to increase duration. Four year increases duration more than the three year (2.875>2). Where’s the confusion? Running all the numbers through, you can either enter into a receive fixed four year swap with a notional of ~$70MM or a receive fixed three year swap with a notional of $100MM.
Confusion is which one to pick and why? All we need is to increase duration by 2. # year swap exactly fits in here.
If I told you that you could increase your duration by buying $1MM worth of 20 year bonds or buying $100MM of one year bonds, which would you pick?
So what you are trying to say is that lesser the notional, better it is?
Final answer.
derswap07 Wrote: ------------------------------------------------------- > So what you are trying to say is that lesser the > notional, better it is? Yes, I think so.
Well, then it makes sense.
If it is an inside joker you guys are pulling on each other, then just ignore this post. Anyway, the real reason is the 3 year swap expires before the desired duration 3.5, so requiring the mgr to enter a new swap, while the 4 year swap does not.
elcfa, You should review our every post and find out our mistakes, otherwise we will lose our credit on the exam without knowing why. TKVM !
Just another good post.