If you funded your fixed-income investment portfolio with short-term deposits, how would you hedge your interest rate exposure with interest rate swaps?
A) Pay fixed and receive floating through swaps for the term of the portfolio
B) Pay floating and receive fixed through swaps for the term of the portfolio
C) You cannot: the maturity of the swaps would be longer than that of the deposits
D) You should not: there would be too much basis risk

Question

Quizplus · Accepted Answer

Pay fixed and receive floating through swaps for the term of the portfolio hedges the interest rate exposure because the fixed payments received from the swap will offset the floating payments on the deposits, resulting in a more stable return.

If You Funded Your Fixed-Income Investment Portfolio with Short-Term Deposits