Consider a five-year equity swap that pays the equity return in return for six-month Libor.Which of the following statements is most valid? Assume you are at the inception of the swap.

Question

Quizplus · Accepted Answer

Since we are receiving Libor,increases in interest rates drop the value of the next Libor coupon.If rates rise and the equity return also rises,then the interest rate risk is even higher,because the equity return to be paid will rise.Hence,equity exposure to interest rates increases the interest-rate risk that is already present.In other words,duration increases and will be higher than six months.The baseline duration of six months follows from the fact that the Libor leg of the swap is a floating rate note.

Consider a Five-Year Equity Swap That Pays the Equity Return