Assume that you manage a $100 million bond portfolio with a duration of 1.5 years. You wish to increase the duration of the bond portfolio to 3.5 years by using a swap. Assume the duration of a fixed-rate bond is 75% of its maturity.

1. Discuss whether the swap you enter into should involve paying fixed, receiving floating or paying floating, receiving fixed.

2. Would you prefer a four-year swap with quarterly payments or a three-year swap with semiannual payments?

3. Determine the notional principal of the swap you would prefer.