CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
An investor holds a bond portfolio and wants to reduce its sensitivity to rising interest rates quickly, at low cost, without selling the bonds. Which action is most likely to achieve this?
Entering a pay-fixed, receive-floating swap is most likely to reduce interest rate sensitivity. The swap gains when rates rise, offsetting losses on the bond portfolio and shortening effective duration, without selling the bonds. Receive-fixed positions would add to rate sensitivity rather than reduce it.
- AEnter a pay-floating, receive-fixed interest rate swap
- BBuy a forward rate agreement as the fixed-rate receiver
- CEnter a pay-fixed, receive-floating interest rate swapCorrect
Explanation
A pay-fixed, receive-floating swap gains value when rates rise, offsetting losses on the bonds and lowering the portfolio's effective duration. Receiving fixed would behave like owning more bonds, increasing sensitivity to rate increases. Being the fixed-rate receiver in an FRA likewise loses when rates rise.
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