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Arnbrook plc (A plc) is considering a £50m 3year int rate swap. It wants to make use of floating rate funds. It can borrowed fixed rate at 6.25% or floating rate at LIBOR + 0.75%. LIBOR is currently 5.25%, but is expected to increase in 6 months. A swap could be arranged with a bank as an intermediary. The bank could offset the swap risk with a counterparty that can borrow fixed at 7.25% and floating at LIBOR + 1.25%. A plc will require 60% of any arbitrage savings from the swap.
If LIBOR was to increase to 5.75% in 6 months, and then stay constant for the period of the swap, estimate the PV of the savings from the swap for A plc. Interest payments are made semi annually in arrears.
Could you please help me with respect to the above?
You really need to watch the free lecture on interest rate swaps, where the effect of swapping is explained.
The only extra bit in this question is the idea of calculating the present value of the savings, but this should not present a problem since this bit is really only standard discounting.Thank you sir. I watched the lecture and I have now understood how to solve the above problem. Many thanks 😀
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