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FRM Part I · FRM Exam Part I · Modeling Non-Parallel Term Structure Shifts and Hedging

A bank's asset portfolio has a DV01 of $135,000, so it loses value when rates rise. The bank wants to neutralize this parallel exposure using 5-year interest rate swaps, each of which has a DV01 of $450 per $1 million notional. Which swap position achieves the hedge?

The bank should pay fixed on a $300 million notional. Dividing the $135,000 DV01 by $450 per $1 million gives 300 million. Paying fixed produces gains when rates rise, which offsets the asset portfolio's losses, whereas receiving fixed would double the exposure.

  1. APay fixed on a notional of $300 millionCorrect
  2. BReceive fixed on a notional of $300 million
  3. CPay fixed on a notional of $600 million
  4. DReceive fixed on a notional of $450 million

Explanation

The notional required is 135,000 / 450 = 300 units of $1 million, or $300 million. A pay-fixed swap gains when rates rise, which offsets the asset losses. A receive-fixed swap would add to the rate exposure instead of offsetting it.

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