Answer: A pair of bonds

## Explanation An interest rate swap can be replicated using a pair of bonds: - **Long a fixed-rate bond** and **short a floating-rate bond** (from the perspective of the fixed-rate payer) - **Short a fixed-rate bond** and **long a floating-rate bond** (from the perspective of the fixed-rate receiver) This replication method is the easiest because: 1. **Direct cash flow matching**: The fixed payments from the swap match the coupon payments from the fixed-rate bond, while the floating payments match the floating-rate bond payments 2. **Simplicity**: Only two instruments are needed, making it straightforward to implement 3. **Standard valuation**: Bond pricing formulas are well-established and easy to apply 4. **No complex derivatives**: Unlike options or futures, bonds are simpler instruments with more transparent pricing Option B (portfolio of interest rate options) and Option C (portfolio of interest rate futures) are more complex and require multiple positions to replicate the swap's cash flows accurately.

Author: LeetQuiz Editorial Team