A pension fund expects a 50 bp cut when the market prices 20 bp. Receive the two-year swap, buy a receiver swaption, or do nothing: how does each choice fare if the cut is 50 bp, 25 bp or zero?

The swap makes Rs 57 lakh if the fund is right, Rs 9.5 lakh on a 25 bp cut and loses Rs 38 lakh on a hold; the swaption makes Rs 20 lakh if right and loses its Rs 18 lakh premium otherwise. Doing nothing scores zero everywhere. The swap pays most when the view is right and keeps losing as the rate rises, while the swaption gives up Rs 37 lakh of the best case for a worst case fixed at the premium.

Start with the thing candidates skip: the market has already moved. A swap rate of 6.80% already carries the 20 basis points of cut that everyone expects, the way a cricket score already includes the runs on the board. What moves the swap is the surprise: a 50 bp cut is a 30 bp surprise and takes the two-year rate to about 6.50%, a 25 bp cut is a 5 bp surprise, 6.75%, and no cut is a 20 bp disappointment that lifts the rate to 7.00%. This one-for-one mapping is the case's simplifying assumption; in practice the two-year rate moves with the whole expected path of policy, and a surprise that changes the path by more than one meeting moves it by more.

Receiving fixed at 6.80% earns when rates fall, by the DV01The change in a position value for a one basis point move in rates. Here Rs 1.9 lakh per basis point on Rs 100 crore of two-year swap. per basis point. On Rs 100 crore the swap makes 30 times Rs 1.9 lakh, Rs 57 lakh, if the cut is 50 bp; 5 times Rs 1.9 lakh, Rs 9.5 lakh, if it is 25 bp; and loses 20 times Rs 1.9 lakh, Rs 38 lakh, if the bank holds. The payoff is a straight line through 6.80%, which is the point: the swap has no floor. If the bank held and also signalled hikes, the two-year rate could rise 40 bp and the loss would double.

The receiver swaptionAn option to enter a swap as the fixed-rate receiver at a set rate. It pays when swap rates fall below the strike. struck at 6.70% costs 18 bp of notional, Rs 18 lakh, paid today. It pays only if the two-year rate ends below 6.70%. On a 50 bp cut the rate is 6.50%, 20 bp through the strike, worth 20 times Rs 1.9 lakh, Rs 38 lakh, so the net gain is Rs 20 lakh; on a 25 bp cut the rate sits at 6.75%, above the strike, and the premium is lost; on no cut the same Rs 18 lakh is lost. The breakeven is a rate of 6.52%, which means the fund needs a cut of about 48 bp before the swaption pays for itself. Think of insurance on a scooter: the premium is gone whether or not you crash, and the policy only pays on a crash big enough to clear the excess.

It turns on how sure the desk is and how much it can lose. If the fund holds its 50 bp view with real conviction, the swap is the better expression: it makes Rs 37 lakh more when right and still earns on a 25 bp cut, where the swaption loses. If the view is a lean rather than a conviction, or the fund's risk committee needs a known worst case, the swaption caps the loss at Rs 18 lakh against the swap's open-ended downside. A middle route is to receive on half the notional and buy the swaption on the other half. Doing nothing is only right if the fund thinks the market's 20 bp is roughly fair, in which case it has no view to trade.

State the limits of the arithmetic. The swaption still has three months of life after the meeting, so a rate at 6.75% leaves it worth something rather than nothing, and the premium actually paid depends on implied volatility, which rises into a contested meeting. The swap's DV01 is a first-order number and the two-year rate rarely moves one-for-one with a single surprise. None of that changes the shape of the answer: a linear instrument for conviction, an option for a lean.