Schweser Vol 2 Exam 2 Derivatives question where there is a $68MM bond outstanding and the guy wants to reduce interest rate risk, how does paying floating and receive fixed reduce your exposure to interest rates (aka reduce duration)?
Floating rate bonds have very low effective duration because they are reset periodically… e.g every 6 months…
Hi c_hal777,
Since you have $68MM bond outstanding, you are paying interest expense, or paying fixed rates on these bonds
To reduce or hedge against the risk of a declining interest rate (since you’ll be paying higher than market rates if that happens), you might want to enter into a swap to pay float and receive fix
By doing that, you offset your pay fix position by receiving fix on the swap, and ultimately paying float (if you anticipate lower interest rates, or just to hedge a large portion of your pay fix expense)
Hope that helps