short question on collars position, question, interest, equivalent, following

Muddahudda

Which of the following is equivalent to a pay-fixed interest rate swap?

A) Buying a cap and selling an interest rate collar.
B) Selling a cap and buying a floor.
C) Buying a cap and selling a floor.
Your answer: A was incorrect. The correct answer was C) Buying a cap and selling a floor.

A pay-fixed interest rate swap has the same payoffs as a long position in the corresponding interest rate collar (with the strike rate equal to the swap fixed rate).




here is my question...if cap and floor rates are the same, i see how you replicate the fixed payments...but in a pay fixed swap, you are also receiving floating rate payments...how is that replicated by buying a cap and selling a floor?

for example, say cap and floor rates are 5%. if rates go above 5%, you will always pay 5% due to the cap. if rates go below 5%, you will still pay 5% do to the floor. waht about the floating rate receipts? seems like buying a cap and selling a floor of the same strike rate only replicates a fixed rate bond.

strikethree

A pay fixed rec floating swap has negative duration, so it benefits when rates increase. Among the choices given, only buy a cap and sell a floor will benefit from rates increase.

mp3bu

ok got it. this is essentially what we learned in level 2 swaps material...that a pay fixed swap is equal to a long call and short put.

thank you guys.