If they didn’t swap, X would be paying 10%. Because there is a saving of 1.5% to be shared equally, X must end up paying 10 – 0.75 = 9.25%.
When they swap X pays Y’s interest of L + 6.5%, X then receives L from Y.. So far therefore X is paying 6.5%.
In order to end up paying 9.25%, X must pay Y 9.25 – 6.5 = 2.75%.
(You can do the same thing for Y and end up with the same transfer)
However don’t worry about the arithmetic – calculations are not asked until Paper AFM. It is just being aware of the idea for Paper FM.
I have not been entirely sure what the mechanism and the real reason behind the movements (interest up and futures down and vice versa). It might have been mentioned in the lecture – sorry if I missed it. But I have found a clear explanation:
“Effect of Interest Income
The futures price decreases when there is a known interest income because the long side buying the futures does not own the asset and, thus, loses the interest benefit. Otherwise, the buyer would get interest if he or she owned the asset.”
Hi Sir, what is there to know about yield curve in interest rate risk management?
For Paper FM you only need to know what is in our free notes and lectures in one of the early chapters.
Hey Sir, what’s the most important hedges for currency and interest rates for the exam?
They are as I state in the lectures.
2.75 paid to x..where did you get that??
It is the missing figure.
If they didn’t swap, X would be paying 10%. Because there is a saving of 1.5% to be shared equally, X must end up paying 10 – 0.75 = 9.25%.
When they swap X pays Y’s interest of L + 6.5%, X then receives L from Y.. So far therefore X is paying 6.5%.
In order to end up paying 9.25%, X must pay Y 9.25 – 6.5 = 2.75%.
(You can do the same thing for Y and end up with the same transfer)
However don’t worry about the arithmetic – calculations are not asked until Paper AFM. It is just being aware of the idea for Paper FM.
Thank you Mr John for your lectures. Your explanations drives the point home
this is great lecture
Love the way you explain with practical examples, and always have an answer for WHY
Hi,
I have not been entirely sure what the mechanism and the real reason behind the movements (interest up and futures down and vice versa). It might have been mentioned in the lecture – sorry if I missed it. But I have found a clear explanation:
“Effect of Interest Income
The futures price decreases when there is a known interest income because the long side buying the futures does not own the asset and, thus, loses the interest benefit. Otherwise, the buyer would get interest if he or she owned the asset.”
It is the missing figure.
If they did their own borrowing they would be paying 10%.
Swapping gives a saving of 1/2 x 1.5% = 0.75%.
Therefore the settling up must end up with X paying 10 – 0.75 = 9.25%
Swapping means they will be paying 12%, so they settle up by Y paying X 9.25% which means X ends up paying 12 – 9.25 = 2.75%.
Remember, however, that as I say in the lectures you cannot be asked to do this calculation in Paper FM – only to explain the idea behind swapping.
hello,how did you get that 2.75 y pay to x from?