Which one of the formulae below is correct?
A) Long a FRN + pay fixed on a swap = long a synthetic straight bond
B) Long a FRN + receive floating on a swap = long a synthetic straight bond
C) Long a FRN + pay floating on a swap = short a synthetic straight bond
D) Long a FRN + pay floating on a swap = long a synthetic straight bond.

Question

Quizplus · Accepted Answer

When an investor is long a floating rate note and also paying floating on a swap, it is equivalent to being long a synthetic straight bond. This is because the floating rate note alone exposes the investor to interest rate risk, but by using a swap to pay floating and receive fixed, the investor effectively creates a fixed-rate investment that hedges against interest rate risk. This synthetic straight bond has the same cash flows as a regular fixed-rate bond and therefore provides the same exposure to credit risk as a regular straight bond.

Which One of the Formulae Below Is Correct