A U.S. pension plan has a 450,000 BPV duration gap with BPV of assets less than of liabilities. The plan uses a swap with a BPV per 100 notional of 0.2571 to construct a 50% hedge ratio.
Question
State the terms and calculate the notional principal of the 50% hedge ratio swap the manager would use.
Answer
(450,000 × 0.50) / (0.2571 / 100) = 87.515 million NP of a receive-fixed swap.
My confusion
Why did the author assume that it would be buying receive-fixed swap? Why can’t it be a selling a pay-fixed swap?
My understanding is that the seller of a pay-fixed swap would pay floating, receive fixed and increase duration. Sounds exactly similar to buying a receive-fixed swap.
I wouldn’t try to look at it that way. Typically, people use the term long to mean _ receiving _ and the term short to mean _ paying _; given that, your phrasing is redundant, and the terms are not similar; they’re opposites of each other.
Forget long and short when talking about swaps. Think pay fixed/receive floating or pay floating/receive fixed. It’s much less stressful on the brain.
Personally, I hate it when people say that they’re buying a swap or selling a swap, just as I hate it when they say that they’re buying or selling forwards or futures. You’re not buying or selling a swap; you’re entering into a swap as a fixed rate payer or a floating rate payer or a fixed rate receiver or a floating rate receiver or whatever, just as you either take the long position or take the short position in a forward or futures contract.
How about swaptions? The terms “buy” and “sell” are used in the text when referring to swaptions.
Is buying a receiver swaption (buying the right to receive the fixed rate) the same as selling a payer swaption (selling the counterparty the right to pay the fixed rate, hence, you receive the fixed rate)?