CFA CFA Level 3 CFAI 2014 – Watanbe Q4

# CFAI 2014 – Watanbe Q4

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• vincentt
Participant
• CFA Level 3
0

Kondo manages a fixed-income portfolio for the Akito Trust. The portfolioâ€™s market value is Â¥640 million, and its duration is 6.40. Kondo believes interest rates will rise and asks Watanabe to explain how to use a swap to decrease the portfolioâ€™s duration to 3.50. Watanabe proposes a strategy that uses a pay-fixed position in a three-year interest rate swap with semi-annual payments. Kondo decides he wants to use a four-year swap to manage the portfolioâ€™s duration. After some calculations, Watanabe tells him a pay-fixed position in a four-year interest rate swap with a duration of â€“2.875 would require a notional principal of Â¥683 million (rounded to the nearest million yen) to achieve his goals.

4.) The duration of the swap in Watanabe’s first proposal to Kondo is closest to:
Solution:

A pay-fixed (receive-floating) position in an interest rate swap is similar to issuing a fixed-rate bond and buying a floating-rate bond with the proceeds. The duration of the fixed-rate bond is approximately 75% of the maturity, and the swap is short this duration. The duration of the floating-rate bond is approximately half its repricing frequency, and the swap is long this duration. Therefore, the duration of the three-year
swap with semi-annual payments is (0.5 Ã— 0.5) â€“ (0.75 Ã— 3) = â€“2.00.

Where did he get 75% of the 3 year duration from?

• RaviVooda
Participant
• CFA Level 3
5

@vincentt, this line mentions it “The duration of the fixed-rate bond is approximately 75% of the maturity, and the swap is short this duration”. if it says 75%, we should use 0.75/year.

• vincentt
Participant
• CFA Level 3
5

@AjFinanceâ€Œ it’s still fine if you forget a formula that you wanted to use, the worse feeling is you have no idea where that formula came from or how did they come up with a magic number 0.75 that’s the most worrying!

But it’s good that we have hardcore candidates like @RaviVoodaâ€Œ and @Alta12â€Œ who uses the underlying text! ^:)^

• vincentt
Participant
• CFA Level 3
4

@RaviVoodaâ€Œ got it. Thanks! I’m not sure if it’s even mentioned in schweser. It’s like giving away free points for not knowing 75%. I need to review quicker, I haven’t even get to the second volume. Are u done with all 3 papers on the second volume?

• RaviVooda
Participant
• CFA Level 3
4

@AjFinance not sure about schweser, but was mentioned in text book

• RaviVooda
Participant
• CFA Level 3
3

@vincentt sorry. However it is the default value we are expected to remember. I think in the exam they will give it

• RaviVooda
Participant
• CFA Level 3
3

@vincentt, I missed out this message. Yes I have completed all 3 sets in the schweser second volume

• 3

@RaviVoodaâ€Œ @vincenttâ€Œ Not sure if this is mentioned in schweser indeed! I got that question wrong as well.

• vincentt
Participant
• CFA Level 3
2

thx @RaviVoodaâ€Œ but the line you highlighted is from the solution and not from the vignette.

• vincentt
Participant
• CFA Level 3
1

@RaviVoodaâ€Œ So a fixed rate duration is always 75% of the bond maturity? It’s a fixed number?

• RaviVooda
Participant
• CFA Level 3
0

@vincenttâ€Œ when nothing is given we take 75%. I remember doing some problem where it was not. In such cases they specify explicitly

• 0

@vincenttâ€Œ exactly! I can’t imagine going through the cfai text. Hats off to @RaviVoodaâ€Œ and @Alta12â€Œ