Howdy, Stranger!

It looks like you're new here. If you want to get involved, click one of these buttons!

CFA Events Calendar

View full calendar

CFA Events Calendar

View full calendar

Recommended Discussions

See how our partners can help you ace your CFA exams.

CFAI 2014 - Watanbe Q4

LondonPosts: 749 Sr Portfolio Manager
Kondo manages a fixed-income portfolio for the Akito Trust. The portfolio’s market value is ¥640 million, and its duration is 6.40. Kondo believes interest rates will rise and asks Watanabe to explain how to use a swap to decrease the portfolio’s duration to 3.50. Watanabe proposes a strategy that uses a pay-fixed position in a three-year interest rate swap with semi-annual payments. Kondo decides he wants to use a four-year swap to manage the portfolio’s duration. After some calculations, Watanabe tells him a pay-fixed position in a four-year interest rate swap with a duration of –2.875 would require a notional principal of ¥683 million (rounded to the nearest million yen) to achieve his goals.

4.) The duration of the swap in Watanabe's first proposal to Kondo is closest to:
Solution:

A pay-fixed (receive-floating) position in an interest rate swap is similar to issuing a fixed-rate bond and buying a floating-rate bond with the proceeds. The duration of the fixed-rate bond is approximately 75% of the maturity, and the swap is short this duration. The duration of the floating-rate bond is approximately half its repricing frequency, and the swap is long this duration. Therefore, the duration of the three-year
swap with semi-annual payments is (0.5 × 0.5) – (0.75 × 3) = –2.00.

@alta12 @RaviVooda‌

Where did he get 75% of the 3 year duration from?

• IndiaPosts: 268 Portfolio Manager
@vincentt, this line mentions it "The duration of the fixed-rate bond is approximately 75% of the maturity, and the swap is short this duration". if it says 75%, we should use 0.75/year.
• LondonPosts: 749 Sr Portfolio Manager
thx @RaviVooda‌ but the line you highlighted is from the solution and not from the vignette.
• IndiaPosts: 268 Portfolio Manager
@vincentt sorry. However it is the default value we are expected to remember. I think in the exam they will give it
• LondonPosts: 749 Sr Portfolio Manager
@RaviVooda‌ So a fixed rate duration is always 75% of the bond maturity? It's a fixed number?
• IndiaPosts: 268 Portfolio Manager
@vincentt‌ when nothing is given we take 75%. I remember doing some problem where it was not. In such cases they specify explicitly
• LondonPosts: 749 Sr Portfolio Manager
@RaviVooda‌ got it. Thanks! I'm not sure if it's even mentioned in schweser. It's like giving away free points for not knowing 75%. I need to review quicker, I haven't even get to the second volume. Are u done with all 3 papers on the second volume?
• IndiaPosts: 268 Portfolio Manager
@vincentt, I missed out this message. Yes I have completed all 3 sets in the schweser second volume
• Posts: 473 Portfolio Manager
@RaviVooda‌ @vincentt‌ Not sure if this is mentioned in schweser indeed! I got that question wrong as well.
• IndiaPosts: 268 Portfolio Manager
@AjFinance not sure about schweser, but was mentioned in text book
• LondonPosts: 749 Sr Portfolio Manager
@AjFinance‌ it's still fine if you forget a formula that you wanted to use, the worse feeling is you have no idea where that formula came from or how did they come up with a magic number 0.75 that's the most worrying!

But it's good that we have hardcore candidates like @RaviVooda‌ and @Alta12‌ who uses the underlying text! ^:)^
• Posts: 473 Portfolio Manager
@vincentt‌ exactly! I can't imagine going through the cfai text. Hats off to @RaviVooda‌ and @Alta12‌