A $250 million bond portfolio has a duration of 5.50. The portfolio manager wants to reduce the
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A $250 million bond portfolio has a duration of 5.50. The portfolio manager wants to reduce the duration to 4.50 by using a swap. Consider the possibility of using a one-year swap with monthly payments or a two-year swap with semiannual payments.
A. Determine the durations of the two swaps under the assumption of paying fixed and receiving floating. Assume that the duration of a fixed-rate bond is 75% of its maturity.
B. Choose the swap with the longer absolute duration and determine the notional principal of the swap necessary to change the duration as desired. Explain your results.
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