market value risk and cash flow risk

[piterinomax]

I understand that entering a pay-fixed receive-float swap we can decrease the cash flow risk.

What i don’t understand is why the duration and hence the market value risk should increase ? When I receive float and pay fixed the duration should decrease as D_pay-fixed = D_floating – D_fixed < 0.

Why does not the rule “add the duration of what is received on the swap, subtract the duration of what is paid on the swap” work here?

thanks

[Jehanzaib_Zafar]

Pay fix swap decreases your CF risk as you lock in a certain CF. However, since the duration of pay fix is higher than the duration of pay floating, the market value risk increases. Reverse is true for pay floating

[piterinomax]

Yeah but I am paying fix so I would assume the sign of the duration is negative in that swap, whereas I receive float and would assume a positive sign. Summing them I would come up with a negative total duration…

[Jehanzaib_Zafar]

Receive floating increases your CF risk … not market price risk … duration is akin to market value

[Moosey]

Because this particular question is from the perspective of a borrower. You chose to pay fix in order to set your cash-outflow fixed (decrease your cash-flow risk) but you end up with a higher duration (in your liabilities) which increases your market risk because your liabilities are more sensitive to interest rate changes.

That was my interpretation of the answer for this q.

[piterinomax]

@Moosey

Because this particular question is from the perspective of a borrower. You chose to pay fix in order to set your cash-outflow fixed (decrease your cash-flow risk) but you end up with a higher duration (in your liabilities) which increases your market risk because your liabilities are more sensitive to interest rate changes.

That was my interpretation of the answer for this q.

OK that sounds quite clear to me.

Though, the net swap duration would still be negative in that case (e.g. D_float=0.5 and D_fix=0.75 --> receiving D=+0.5 but offset by my float loan with D=-0.5 and paying D=-0.75 on the fix => net duration D=-0.75). Am I missing a sign issue here?

Thanks a lot

[S2000magician]

Standalone, your market value risk changes the same amount whether you’re paying floating and receiving fixed or paying fixed and receiving; they’re simply in opposite directions. Same for cash flow risk.

Whether your overall risk increases or decreases depends on the rest of your portfolio.

[piterinomax]

@S2000magician

Standalone, your market value risk changes the same amount whether you’re paying floating and receiving fixed or paying fixed and receiving; they’re simply in opposite directions. Same for cash flow risk.

Whether your overall risk increases or decreases depends on the rest of your portfolio.

Ok put it in this way it’s sounds much more reasonable to me.

Schweser states: “If interest rates fall, the liability will rise in market value,…”. That would mean that the duration has increased … so I still don’t get the duration signs in the SWAP.

[mheithy]

@Moosey

Because this particular question is from the perspective of a borrower. You chose to pay fix in order to set your cash-outflow fixed (decrease your cash-flow risk) but you end up with a higher duration (in your liabilities) which increases your market risk because your liabilities are more sensitive to interest rate changes.

That was my interpretation of the answer for this q.

wait, you said pay fixed would heighten duration…how is this so?

[piterinomax]

@mheithy

@Moosey

Because this particular question is from the perspective of a borrower. You chose to pay fix in order to set your cash-outflow fixed (decrease your cash-flow risk) but you end up with a higher duration (in your liabilities) which increases your market risk because your liabilities are more sensitive to interest rate changes.

That was my interpretation of the answer for this q.

wait, you said pay fixed would heighten duration…how is this so?

that’s my point too.