Economics · Financial Derivatives
A sophisticated treasury department of a large public sector bank is looking to hedge its long-term exposure to fluctuations in the domestic interest rate environment using Interest Rate Swaps. Which of the following accurately describes the technical mechanics of a Plain Vanilla Interest Rate Swap where a bank chooses to 'pay fixed and receive floating' interest payments?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The floating rate is typically determined based on the long-term yield of the 10-year Government of India dated security to ensure the swap remains a long-term hedging tool.
- 2There is an actual exchange of the underlying principal amount at the inception of the contract and again at maturity to fully mitigate credit risk.
- 3The bank is attempting to hedge against rising interest rates because as market rates increase, the floating receipts will increase while the fixed outgoing payment remains constant.✓
- 4The bank expects interest rates to fall in the future so that the fixed rate it pays becomes cheaper than the market average while it receives higher floating payments.
Correct answer
The bank is attempting to hedge against rising interest rates because as market rates increase, the floating receipts will increase while the fixed outgoing payment remains constant.
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