Interest rate risk – swap

If there was no swap then L would borrow fixed at 5.6% and the counterparty would borrow floating at L + 1.5%. So a total of L + 7.1%

If they swap then L will borrow at L + 0.5% and the counterpart will borrow at 6.1% (and then they pay each others interest). So the total is L + 6.6%

Therefore there is a total saving to be made of 0.5% less the bank changes of 0.2% giving a net saving of 0.3% shared equally, so 0.15% each.

Without the swap L would be paying 5.6%. Since swapping will save 0.15%, L will end up paying only 5.45%.

This is achieved as follows:
L pays the counterpartys interest of L + 0.5%
The counterparty pays L at Libor, which means that so far L is paying 0.5%.
We have already determined that the end result should be that L will end up paying 5.45% after bank charges of 0.10% (so 5.35% before bank charges). So to make that happen, L must pay the counterparty 5.35 – 0.50 = 4.85%

You are welcome 🙂