The manager of a savings and loan associa- tion is considering the use of a swap as part of its asset/liability strategy. The swap would be used to convert the payments of its port- folio of fixed-rate residential mortgage loans into a floating payment.

a. What is the risk with using a plain vanilla or generic interest-rate swap?

b. Why might a manager consider using an interest-rate swap in which the notional principal amount declines over time?

c. Why might a manager consider buying a swaption?

AppendixLO1