
AuthorPosts


Kondo manages a fixedincome portfolio for the Akito Trust. The portfolio’s market value is ¥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 portfolio’s duration to 3.50. Watanabe proposes a strategy that uses a payfixed position in a threeyear interest rate swap with semiannual payments. Kondo decides he wants to use a fouryear swap to manage the portfolio’s duration. After some calculations, Watanabe tells him a payfixed position in a fouryear interest rate swap with a duration of –2.875 would require a notional principal of ¥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 payfixed (receivefloating) position in an interest rate swap is similar to issuing a fixedrate bond and buying a floatingrate bond with the proceeds. The duration of the fixedrate bond is approximately 75% of the maturity, and the swap is short this duration. The duration of the floatingrate bond is approximately half its repricing frequency, and the swap is long this duration. Therefore, the duration of the threeyear
swap with semiannual payments is (0.5 × 0.5) – (0.75 × 3) = –2.00.Where did he get 75% of the 3 year duration from?


thx @RaviVooda but the line you highlighted is from the solution and not from the vignette.


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


@RaviVooda 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 @vincentt Not sure if this is mentioned in schweser indeed! I got that question wrong as well.

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

@AjFinance 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 @RaviVooda and @Alta12 who uses the underlying text! ^:)^

@vincentt exactly! I can’t imagine going through the cfai text. Hats off to @RaviVooda and @Alta12


AuthorPosts
 You must be logged in to reply to this topic.