Why would a company that owns a floating rate asset enter into a vanilla swap as a fixed rate receiver?

Question

BlackTom AI · Accepted Answer

Question restatement: Why would a company that owns a floating rate asset enter into a vanilla swap as a fixed rate receiver?

Option provided: "Because they believe interest rates are going to decrease."

Analysis of the option:
- If the company holds a floating-rate asset, its cash flows fluctuate with reference rates: when rates rise, the asset pays more; when rates fall, it pays less. By entering a swap as a fixed-rate receiver, the company would additionally receive a fixed payment and pay a floating payment.
- The hedging intuition behind this is that if interest rates are expected to fall, the floating payments the asset yields are likely to decrease. By also receiving fixed in the swap, the company would lock in a steady fixed inflow, which can be more favorable relative to shrinking floating receipts, thereby reducing exposure to falling rates.
- Put differently, the strategy can convert part of the floating-rate exposure into a more predictable fixed stream, which aligns with a view that rates will decline. This makes the hedging intent plausible under the expectation of falling rates.

Possible misconceptions or caveats:
- If rates were expected to rise, a company might prefer to receive floating and pay fixed (the opposite of the stated action) to gain from higher floating receipts, so this option would be contrary to such a view.
- The effectiveness of this hedge depends on basis risk and the duration mismatch between the asset and the swap; simply being a fixed-rate receiver does not guarantee perfect hedging against rate moves.
- The reasoning assumes a directional view on rates (decrease). If the company’s risk management policy prioritizes different hedges or uses more tailored instruments, the rationale might differ.

Summary: The option ties the decision to an expectation of declining rates, which would make receiving fixed in a swap serve as a hedge against falling floating payments from the asset. Given only this option, the explanation aligns with typical hedging logic for converting floating exposure to a more predictable fixed stream when a rate decline is anticipated.

BU.232.710.W1.SP25 Quiz #2

Why would a company that owns a floating rate asset enter into a vanilla swap as a fixed rate receiver?

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