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Interest Rate Swap Introduction

The document discusses interest rate swaps, including how they allow two counterparties to exchange interest rate cash flows to hedge against risks. It defines key terms like payer, receiver, and notional principal. It also provides an example of how two companies, Apple and Boeing, could use an interest rate swap to take advantage of their comparative advantages in the fixed vs floating rate markets.

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Manish Anand
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© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
66 views

Interest Rate Swap Introduction

The document discusses interest rate swaps, including how they allow two counterparties to exchange interest rate cash flows to hedge against risks. It defines key terms like payer, receiver, and notional principal. It also provides an example of how two companies, Apple and Boeing, could use an interest rate swap to take advantage of their comparative advantages in the fixed vs floating rate markets.

Uploaded by

Manish Anand
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Interest Rate

Swap
Swap is an agreement between two parties,
called Counterparties, who exchange future cash
flows over a period of time based on market
Interest Rate Swaps
Commodity Swap
Currency Swaps and more

A commodity producer wishes to fix his income


and would agree to pay the market price to a
financial institution, in return for receiving fixed
payments for the commodity.
Mitigate Price Risk
Lower Progressive Tax
Odie Pichappan

Interest Rate Swap

Swap Terminolog
Long Swap (Buyer)
Counterparty that receives variable/floating cash
flow
Short Swap (Seller)
Counterparty that is paying variable/floating
Buyer
Seller
cash
flow
Fixed
Floatin
g
to
Fixed

Odie Pichappan

Party-A
Payer

Party-B
Receiver

to
Floatin
g

Payer counterparty that pays fixed


rate.
Receiver counterparty that receives
Interest Rate Swap
fixed rate.

Swap
Terminology
Day count convention (Yield basis) determines how
interest accrues over time period (Actual/360 float, 30/360
fixed).
ISDA - International Swaps and Derivatives Association, Inc.
Notional principal amount on which the periodic payment
of cash flow is calculated.
Payment period interest calculation period and cash
exchanged at the end of the period.
Rate fixing normally done 2 days before start of period.
Tenor Maturity of the swap

Odie Pichappan

Interest Rate Swap

Comparative
Advantage
Apple Inc wants to borrow at floating rate and
Boeing Co wants to borrow at fixed rate, under
following
borrowing rates.
Counterparty
FIXED RATE
FLOATING
RATE
APPLE INC

6.25%

LIBOR + 1.11%

BOEING CO

7.66%

LIBOR + 2.34%

Difference

1.41%

1.23%

Apple has relative advantage in fixed market and


Boeing has relative advantage in floating market.
The total arbitrage gain by entering into a swap
deal would be 1.41% - 1.23% = 0.18%
Design a swap where the gain are equally shared
between the 2 companies and the swap dealer.
Odie Pichappan

Interest Rate Swap

Comparative Advantage
Calculation
gained 6 bps

gained 6 bps
LIBOR

gained 6 bps
LIBOR

Boeing

Apple

Net 7.60%

Net L+1.05

5.26%
LIBOR + 2.34%

5.20%
6.25%

Both counterparties gained 6 bps by borrowing


in their preferred market where they have
comparative advantage.
Odie Pichappan

Interest Rate Swap

Counterparty
Report

Odie Pichappan

Interest Rate Swap

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