Reducing Interest Rate Risk

CFA Level II Derivatives
#1

Hi folks,

Here is the background information:

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And here is the question:

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The correct answer is apparently B.

But why? If interest rates are likely to rise, why would paying a floating rate be beneficial if TorkSpark might end up paying more than 6.25% ?

Thanks in advance, folks

#2

The objective is to reduce interest rate risk; i.e., reduce (absolute) duration.

They’re short duration now, so they want to add duration. A decreases duration, B increases duration, C decreases duration.

#3

Thanks very much @S2000magician

But why are they short duration now?

And how does entering into a derivative contract change the duration, when duration is the price sensitivity of the bond to interest rate changes? How do the derivatives influence the price of the bond?

Thanks in advance.

#4

They issued (sold) bonds.

Derivatives don’t influence the price of the bond. They have their own interest rate sensitivity, so they have their own duration.

#5

Thanks @S2000magician , always appreciate your help and wisdom!

#6

My pleasure.