FRM Part I · FRM Exam Part I · Swaps
A bank has issued a 5-year fixed-rate bond and wants to convert its liability to floating. Which swap position achieves this, and what is the effect on its exposure?
The bank should receive fixed and pay floating. The fixed receipts offset the bond coupons, leaving a net floating-rate funding cost, so the bank gains when rates fall and loses when they rise.
- AEnter a swap paying fixed and receiving floating, which leaves it exposed to falling rates
- BEnter a swap receiving fixed and paying floating, so its net cost floats and it gains if rates fallCorrect
- CEnter a swap paying fixed and receiving floating, so its net cost floats and it gains if rates rise
- DEnter a swap receiving fixed and paying floating, which locks in the cost of funding at a fixed rate
Explanation
The bank pays fixed on the bond and receives fixed on the swap, which offsets the bond coupon. It pays floating on the swap, so its net funding cost becomes floating. It benefits when rates fall because the floating payments decline. Paying fixed would double the fixed exposure.
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