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Dear John,
Thanks for your lectures, it’s really helpful to understand but one point I didn’t get clearly understand on example2. How did you calculate “Y will pay X for 2.75% is it possible to explain more details?
Thank you !If X did its own borrowing they would be paying 10%. There is a saving to be made of 0.75% (1/2 x 1.5%) and so they must end up paying 10 – 0.75 = 9.25%.
However, just swapping would mean them paying the 12% that Y will have borrowed at. So for them to end up paying only 9.25% they must receive 12 – 9.25 = 2.75% from Y.
Similarly, if Y did its own borrowing then they would be paying L + 6.5%. Because of the saving they must end up paying only L + 6.5 – 0.75 = L + 5.75%.
However just swapping would mean then only paying X’s interest of L + 3%. So to end up with them paying L + 5.75% then need to pay the extra 2.75% to X.
However, do appreciate that although you are expected to know what swaps are for Paper F9, you are not tested on the arithmetic in F9 (only at P4).
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