Interest rate swap question in an interview with a Major IB

[gsjayaraman]

Hi All,
I'm left a bit baffled after i had a telephonic interview with a major IB in London. It was for a FO position as a quant developer in credit derivatives and i was expected to have knowledge of interest rate derivatives. So the interviewer asks me what an interest rate swap is which i answered, then asked me how it could be valued. I then proceeded to explain that if a certain party receives fixed and pays floating then it can be considered equivalent to the party having a long position in a fixed rate bond and a short position in a floating rate bond. The value of the swap at any time to the party is the difference in value of these bonds. He then asks me which of the two bonds have greater interest rate risk. I explained that the fixed rate bond will have greater interest rate risk simply because it has the same maturity as the life of the swap whereas the floating rate bond can only be considered to have maturity until the next reset date when the interest rate is revised. Thus the duration of the fixed rate bond will be greater than the floating rate bond thus resulting in the former having greater interest rate risk. He did not ask me any more questions after that and i felt quite confident that i did well. Though, later on i was shocked to find out from the recruitment consultant that they did not want to take the process further since my knowledge of interest rate derivatives was not good enough. I need to know where if any, i went wrong above, since i looked up Hull and i still can't figure out where i might have screwed up.
Cheers.
Sankar.

 

[John]

Perhaps they were expecting you to talk a bit about rates directly, as ir swap is a pure bet on interest and can be priced directly from the observed rates. (your analogy of thinking of a swap in terms of owning long/short fix/float bonds is valid though)

Value to a fix swap payer = Sum of the difference between fixed swap rate & forward rate, discounted at risk free rate, for each of the accrual period between present & maturity, times the notional amount.

A lot of times, you never know the real reason a candidate is being passed over. They might be interviewing several candidates at the same time. At least they gave you a feedback.