Interest rate swap split calc

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    harripool
    Participant

    Hi John,

    Lecture example 2 chapter 21.
    Can you explain how we arrive at:
    ‘B’ pays ‘A’ 0.75%

    I understand how we arrive at a split of 0.25% each, but not how this equates to a 0.75% payment?
    I’m obviously missing something simple here, but can’t figure it out!

    Much appreciated


    Profile photo of John Moffat
    John Moffat
    Keymaster

    If company B were to borrow directly at fixed, they would be paying 11%, and so if they are to save 0.25% they must end up paying 10.75%.

    Swapping with A would mean they would be paying 10%, so to make it up to 10.75% they pay 0.75% to A.

    Similarly, if A were to borrow directly at floating, they would be paying L + 1%, and so if they are to save 0.25% they must end up paying a net L + 0.75%.

    By swapping with B they will be paying L + 1.5%, but if they receive 0.75% from B then the net payment will be L + 0.75%


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    harripool
    Participant

    Eureka! Thanks John


    Profile photo of John Moffat
    John Moffat
    Keymaster

    You are welcome :-)


    Profile photo of indiffacca
    indiffacca
    Participant

    sir dec 14 keshi co, i cant apply this cocept to that question please help


    Profile photo of John Moffat
    John Moffat
    Keymaster

    Have you watched the free lecture on interest rate swaps?


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    piggeed
    Participant

    Hi John,

    I watched the video lecture on interest rate swaps and apply the concept to Dec 14 Keshi Co:

    own: Keshi Co would borrow floating L + 0.4%, and Counter-party would borrow at fix rate 4.6% => Total L + 5%

    Swap: Keshi Co now borrows fix 5.5%, Counter-party borrows floating L + 0.3% => Total L + 5.8%.

    Can we say that the saving is 0.8%? In this case, I see the swap costs 0.8% more, not less.

    Appreciate your advice. Many thanks


    Profile photo of John Moffat
    John Moffat
    Keymaster

    It depends whether Keshi would prefer to end up paying fixed interest or floating interest.

    If they wish to end up borrowing fixed (and do it by borrowing floating and then swapping) then there is a saving to be made of 0.8% in total.

    The advantage of arranging a swap and ending up paying fixed interest is that there is the saving. The potential downside is that if LIBOR were to fall then they will not get the benefit of the lower interest and may have been better off to have borrowing floating and not to have entered into the swap arrangement.

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