Question

An interest rate swap can be interpreted as a position in two cash market instruments. What are they from the buyer’s perspective?

____

1.    A long-side of a floating-rate bond and a short position in a fixed-rate bond
2.    Purchasing a fixed-rate bond and issuing at a floating-rate
3.    Going long and short simultaneously in a floating-rate bond
4.    Buying a long-term bond and financing with a short-term bond

Answer 1

Swaps are always quoted in terms of fixed rate. Similar to a currency option, the option is always on the currency, whose 1 units is being priced in terms of the other currency. So from the buyer's perspective, he is long the fixed rate and short the floating rate. So Option B is correct because buying a fixed rate bond and selling a floating rate bond will give him the same the same exposure as the swap.

As option B is correct option A is incorrect because it states the opposite.

If nothing is specified, then one leg of the swap is fixed so option C is incorrect.

Suppose the swap has a life of 3 years. This can be acheived by being long in a 4 year bond and short in a 5 year bond. As long as both the bonds have at leas as much time to matuirty to cover the life of the swap. So this implies that the exposure is long on short term bond and short on the long term bond. Therefore option D can be incorrect or correct. It cant be said conclusively which leg is invested in a long term bond and which in a short term bond.