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Swap Example

A SWAP is an agreement between two parties to exchange interest payments on a set notional principal amount at specified intervals. One party pays a fixed interest rate while the other pays a floating rate, typically tied to a benchmark interest rate like LIBOR. This allows parties to swap fixed for floating rate obligations or vice versa, transforming the interest rate characteristics of their debt or investments.

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32 views

Swap Example

A SWAP is an agreement between two parties to exchange interest payments on a set notional principal amount at specified intervals. One party pays a fixed interest rate while the other pays a floating rate, typically tied to a benchmark interest rate like LIBOR. This allows parties to swap fixed for floating rate obligations or vice versa, transforming the interest rate characteristics of their debt or investments.

Uploaded by

kapoorraghav7777
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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SWAP

A SWAP is an agreement to
exchange cash flows at specified
future times according to certain
specified rules

Prentice Hall 1
Typical Uses of an
Interest Rate Swap

 Converting a liability from


 fixed rate to floating rate
 floating rate to fixed rate

 Converting an investment from


 fixed rate to floating rate
 floating rate to fixed rate

2
An Example of a “Plain Vanilla”
Interest Rate Swap

 An agreement by Microsoft to receive


from Sunlife 6-month LIBOR & pay a
fixed rate of 5% per annum to Sunlife
every 6 months for 3 years on a
notional principal of $100 million
 What will the cash flows look like?

3
Cash Flows to Microsoft

---------Millions of Dollars---------
LIBOR FLOATING FIXED Net
Date Rate Cash Flow Cash Flow Cash Flow
Mar.5, 2010 4.2%
Sept. 5, 2010 4.8% +2.10 –2.50 –0.40
Mar.5, 2011 5.3% +2.40 –2.50 –0.10
Sept. 5, 2011 5.5% +2.65 –2.50 +0.15
Mar.5, 2012 5.6% +2.75 –2.50 +0.25
Sept. 5, 2012 5.9% +2.80 –2.50 +0.30
Mar.5, 2013 6.4% +2.95 –2.50 +0.45

4
Sunlife (SL) and Microsoft (MS)
Transform a Liability
5%

5.2%
SL MS
LIBOR+0.1%
LIBOR
Microsoft SL
Loan Payment LIBOR + 0.1% 5.2%
Add: Paid under swap 5.0% LIBOR
Less: Received under swap - LIBOR - 5%
Net Payment 5.1% LIBOR + 0.2%
5
Financial Institution is Involved
4.985% 5.015%

5.2%
SL F.I. MS
LIBOR+0.1%
LIBOR LIBOR

Microsoft SL
Loan Payment LIBOR + 0.1% 5.2%
Add: Paid under swap 5.015% LIBOR
Less: Received under swap - LIBOR - 4.985%
Net Payment 5.115% LIBOR + 0.215%

6
Intel and Microsoft (MS)
Transform an Asset
5%
4.7%
SL MS
LIBOR-0.2%

LIBOR
Microsoft SL
Investment Income 4.7% LIBOR – 0.2%
Less: Paid under swap - 5.0% - LIBOR
Add: Received under swap LIBOR 5%
Net Income LIBOR – 0.3% 4.8%

7
Financial Institution is Involved
4.985% 5.015%

4.7
SL F.I. MS %
LIBOR-0.2%
LIBOR LIBOR

Microsoft SL
Investment Income 4.7% LIBOR – 0.2%
Less: Paid under swap - 5.015% - LIBOR
Add: Received under swap LIBOR 4.985%
Net Income LIBOR – 0.315% 4.785%

8
Quotes By a Swap Market Maker
Maturity Bid (%) Offer (%) Swap Rate (%)
2 years 6.03 6.06 6.045
3 years 6.21 6.24 6.225
4 years 6.35 6.39 6.370
5 years 6.47 6.51 6.490
7 years 6.65 6.68 6.665
10 years 6.83 6.87 6.850

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