Questions about the DV01 and duration of interest rate swap
Silly questions here, but I am trying to teach myself some basics about interest rate swaps and am unable to find simple explanations online:
Questions:
1) Why does an interest rate swap have no duration, but it does have a DV01?
My confusion arises from a lack of understanding between the difference between duration and DV01. Both concepts have been explained to me as being equal/proportional to the slope of price-yield curves, so I am confused why a swap would have one property, but not the other
2) What does it mean for the fixed leg of an interest rate swap to have positive DV01?
Once again, I think of DV01 as being d(Price)/d(rate). However:
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I am not sure what rate I would be referring to in d(rate) with a vanilla IRS as there is curve for the rate.
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I can understand in general that if rates rise, then the present value of the fixed payments will decrease (as the discounting factors increase with higher interest rates), but am not sure what 'price' is being referred to here
3) Similarly, why does the floating leg of a swap have negative DV01, but contributes to positive DV01 since investor is paying floating?
Thanks in advance.
Hey bobzen, I'm the WSO Monkey Bot...do any of these help:
More suggestions...
Hope that helps.
bump. would be great to have input from rates traders
in short terms, strictly speaking a swap doesn't have a duration because the time weighted average of cashflows is uncertain but does have DV01 because there is a present value in dollar terms associated with a 1bp rise in the swap rate.
I'm in FICC trading- we use swaps (and other credit derivatives) to hedge our long end duration:
1) Why does an interest rate swap have no duration, but it does have a DV01?
Every spread product has duration and DV01 since all are sensitive to underlying moves in rates. To calc duration on a swap it's your notional/DV01 * 10k. As your swap reaches maturity the duration and DV01 factors down. Longer duration swaps, say 10Y vs 2Y, will inherently have more duration. Ex. a 10Y swap will have a duration slightly less than 10 depending on how much time to maturity left on the position.
For 2 and 3, do not think of each leg of the swap having DV01. Rather, the entire swap itself (both legs) is one position with DV01 depending on if you are paying/receiving fixed vs float.
2) What does it mean for the fixed leg of an interest rate swap to have positive DV01?
If you pay fixed and receive float, the entire swap has a positive DV01. Rates sell off (go higher), and you receive positive PnL on the position = positive DV01.
3) Similarly, why does the floating leg of a swap have negative DV01, but contributes to positive DV01 since investor is paying floating?
If you are paying floating and receiving fixed, the DV01 is negative since as rates go higher you need to pay out a higher amount which results in negative PnL on the position and thus negative DV01.
Thank you very much, that makes more sense now. When we say 'rates' sell-off or rally, which rates are we talking about? Are we talking about the 'fixed rate' (i.e. the rate of the fixed leg that we are paying, which is akin to an average of the floating rates over the tenor)? Or are we talking about a specific floating rate (e.g. the 2y DV01 could be the pnl impact of a basis point change in the 2y floating rate? I seem to hear traders referring to different buckets of DV01 exposure (based on tenor) - maybe I am wrong - but that would suggest that these exposures are being calculated with respect to movements of different points along the curve.
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