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Dear Sir Moffat.
Your lecture note and delivering are quite outstanding. Thank you. However, I am still challenged with Interest Swap. I have an understanding of how saving is arrived it and net cost but when it comes to the parties paying own rate and being paid or paying the other parties under the swap arrangement I dont understand what determines what each party pays the other. I have gone through your past exam video lecture and applied the understanding in other question but it didnt give the expected result. Please what is the rule to apply when the parties are paying or receiving from one another under the swap, ThanksThe best approach really is as follows:
Having worked out the saving to be made (which it seems you are happy with), then subtract this from the interest that they would have been paying if there was no swap available. This gives you what you want to end up with.
Then write down the interest they will be paying before actually swapping.
Then whichever one wants to end up paying floating – have them pay Libor to the other one.
Then calculate the missing figure to make the total equal to the amount you want to end up with – that is the other payment between the parties.(I am sorry but it is difficult to write it all in words – I hope it makes sense. Judging by the time the current examiner asked it, it seems he is more interested in just showing the saving rather than the actual mechanics of ‘who pays who’ 🙂 )
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