A pay-fixed interest rate swap can be viewed as equivalent to
A) A long position in a par valued FRN and a long position in a par valued fixed rate note.
B) A long position in a par valued FRN and a short position in a par valued fixed rate note.
C) A short position in a par valued FRN and a long position in a par valued fixed rate note.
D) A short position in a par valued FRN and a short position in a par valued fixed rate note.
E) None of the above.

Question

Quizplus · Accepted Answer

A pay-fixed interest rate swap involves one party paying a fixed rate and receiving a floating rate, while the other party pays a floating rate and receives a fixed rate. The party receiving the fixed rate is essentially making a fixed rate loan to the other party. This can be replicated by purchasing a fixed rate bond and selling a floating rate note with the same notional value. Therefore, the pay-fixed interest rate swap can be viewed as a long position in a par valued fixed rate note and a short position in a par valued FRN, which is equivalent to choice B.

A Pay-Fixed Interest Rate Swap Can Be Viewed as Equivalent