Question on swaption and rates

CFA Level III Derivatives
#1

Hello,

Can someone help me figure out why buying a 2.3% receiver swaption when rates rise above 3.3% is a good idea? To my understanding, if you buy a 2.3% receiver swaption and rates rise above 3.3%, you locked in a lower rate. How is that beneficial if it expires worthless?

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#2

Tough one, but if you take a good look (and if I am correct about the holistic approach over all 3 alternatives), maybe it might not be that technically incorrect.

If the rates rise above 3.3%, e.g. to 4.0%, then:

  • alternative 1 generates loss of 1.5%
  • alternative 2 (in best case) generates loss of 0.7% + net premium → under presumption buyer would not exercise receiver swaption and the other buyer would activate payer swaption.
  • alternative 3 would generates solely the premium loss if he leaves the swaption unexercised

This is just mine hard logic, but am not 100% sure, and besides, would not rely on notes based on slides.

#3

So essentially you’re saying that Option 3 generates the least loss of the 3 options. Makes sense. Was poorly worded by Kaplan Schweser in that sheet. But thanks that’s helpful!