Swaps and Convenience Yield points, amount, against, question, choosing

Palantir

Two points of clarification from 2009 exam.

1. In the swaps question (8B) where she desires a notional amount close to the value of her bond, she ends up choosing a quarterly pay swap to hedge a semiannual pay bond. To me, that's odd and against what we have learned. My assumption is that this is normally not preferred but her unique concern to have a swap notional amount equal to bond value overided that issue--correct?

2. In question 8A, the answer asks for the effect on roll yield. There are two different factors in play. One is increase in convenience yield (which causes backwardation) and one is increase in interest rates (which causes contago). Are we to just assume any time there are opposing forces that they will offset and thus the result will always be no change, as the answer spcifies here?

skycfa

yea, that equals the notional principal of the swap

Darien

whats the logic about the calculation of the notional principal.
in the formula i have it would bond ((mdur TARGET - mdur bond )/ mdur SWAP).

canadiananalyst

I agree with bpdulog. If we aren't given numbers to use in a calculation, then we can only look at the direction of the changes. So here are the 4 possibilities:
1. Interest rate increase + convenience yield increase = no change
2. Interest rate increase + convenience yield decrease= increase in roll yield
3. Interest rate decrease + convenience yield increase = decrease in roll yield
4. Interest rate decrease + convenience yield decrease = no change

thommo77

That has to be the case unless they give you hard numbers.

NO EXCUSES

mp3bu

how about question 8A? if two factors are in play causing something to go in opposite directions do we always put no increase or no change

nannan66

8B - there were two issues

the semi annual bond - had a much higher Notional Principal.
Original Liability was 4 years - which required to be swapped. If the Semi-annual bond was used - it was a 2 year Swap - so you would need two swaps as well over the life of your liability at about more than 2 times the NP for each time (113 vs 259)

CP

bkballa

so in other words, swap 1 had two things wrong (notional amount and term) but swap 3 had only one thing wrong (payment frequency) and says she said she cares about notional amoutn we chose swap 3?