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PRMIA Exam 8006 Topic 8 Question 81 Discussion
Topic #: 8
An investor can use which of the following to replicate a fixed for floating interest rate swap where the investor pays fixed and receives floating?
1. Long positions in a series of forward rate agreements (FRAs)
II. A short position in a fixed rate bond and a long position in a floating rate note
III. A long position in a floating rate note and a short position in an FRA
IV. A long position in an interest rate cap and a short position in an interest rate floor at the same strike
Commodity futures prices can be expressed as the summation of their spot prices and the carrying costs. Therefore any changes in either of these two would be a risk to the futures prices, and Choice 'b' is the correct answer. It is common to decompose complex commodity portfolios into underlying equivalent spot positions and the carrying costs, which includes interest, convenience yield and storage costs. For liquid commodities such as gold where changes of a short squeeze are low, interest costs dominate the carryings costs. Choice 'b' is the correct answer as it is most complete and covers the elements in the other choices. The 'lease rate' for a commodity is equivalent to (Fwd Price - Spot Price)/Spot Price, and comprises the interest and storage costs and the convenience yield. The other choices do not represent complete answers.
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