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FRM Part I · FRM Exam Part I · Swaps

A corporate treasurer has issued a 5-year floating-rate loan and wants to convert it into a fixed-rate liability using a swap. Which position in a plain vanilla interest rate swap achieves this, and what is the resulting exposure in the swap?

The treasurer should pay fixed and receive floating. The floating receipts offset the floating loan interest, leaving a net fixed cost. A pay-fixed swap gains value when interest rates rise, because the floating receipts increase while the fixed payments remain unchanged.

  1. APay fixed, receive floating; the swap gains value if rates riseCorrect
  2. BPay floating, receive fixed; the swap gains value if rates rise
  3. CPay fixed, receive floating; the swap gains value if rates fall
  4. DPay floating, receive fixed; the swap gains value if rates fall

Explanation

Receiving floating offsets the floating loan interest, leaving the fixed payment as the net cost. A pay-fixed position is like long a floating-rate bond and short a fixed-rate bond, so its value rises when rates rise. Pay-floating positions would double the floating exposure.

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