Question of the Week

Which of the following strategies is (are) appropriate?

I. If a borrower has a fixed rate debt and is expecting interest rates to rise, then the borrower should not enter into a swap.
II. If an investor has floating rate assets and is expecting interest rates to rise, then the investor should enter into a swap in order to receive fixed and pay float.
III. If a borrower has floating rate debt and is expecting interest rates to rise, then the borrower should enter into a swap in order to receive float and pay fixed.
IV. If an investor has fixed income assets and is expecting interest rates to drop, then the investor should enter into a swap in order to receive float and pay fixed.

a) I and III only
b) I, III and IV only
c) I and II only
d) II and IV only


Answer:

The correct answer is: a)

(II) is incorrect because if an investor has floating rate assets and is expecting interest rates to rise, then the investor should not enter into a swap. If the asset has a floating rate, then as interest rates rise, so will the income from the asset. (IV) is incorrect because if an investor has fixed income assets and is expecting interest rates to drop, then their assets will appreciate in value. Consequently, they should not hedge against this potential by entering into a swap.


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