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

A fund holds bonds with a DV01 of $12,000 per basis point, concentrated around the 7-year point. A 7-year interest rate swap has a DV01 of $400 per $1 million notional for the fixed-rate payer, who gains when rates rise. To hedge the fund's rate exposure with this swap, which trade is appropriate?

Pay fixed on $30 million notional. The bonds lose $12,000 per basis point when rates rise, and a pay-fixed swap gains $400 per $1 million, so 12,000 divided by 400 gives 30 million. Receiving fixed would add to the exposure.

  1. AReceive fixed on $30 million notional
  2. BPay fixed on $30 million notionalCorrect
  3. CPay fixed on $3 million notional
  4. DPay fixed on $48 million notional

Explanation

The bond fund loses $12,000 per bp when rates rise, so it needs a position that gains when rates rise: pay fixed. Notional = 12,000 / 400 = 30 units of $1 million, i.e. $30 million. Receiving fixed would double the exposure.

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