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dear Sir
i understand the forward rates, I understand how swaps work. Perhaps i do not understand how the question is asked.
I believe the following:
1. Pault was going to have to pay yield curve spot rate (not forward rate) plus 50pts for 4 years…total interest 89.6m2. Bank offered him 4.847% p.a for 4 years …cost 77.552 plus fees 4m = 81.552m
3. I just don’t even understand where the swap comes into it other than he receives possibly another 920,000 from the net on the swap
4. the swap rate is based on the forward rate minus 20 pts and so on…so each year there is a net…..but why wouldn’t he just accept the 4.847 based on the offer
There is no other customer with bad rates looking to benefit from pault’s rates…there is no point to the transaction…where is the gain for anyone??? pault could take the 4 847 and save 8 million and not bother with the swap
Pault is currently paying floating interest.
The question says that he is expecting interest rates will increase and therefore he prefers to pay fixed interest.
If he swaps in the manner given in the question, then he ends up paying fixed interest.Whether he ends up gaining or losing is not the issue here – by swapping to fixed interest he will no longer have the exposure to the risk of changes in the interest rates.
I understand exactly what you are saying.
i do not understand how he is offsetting a full interest amount of his floating against his fixed. i could understand if he ws offsetting a gain of a smaller amount as a result of saving someone else some money.
the only way i can see a full offset is by Pault depositing cash somewhere at those rate
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