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issues with interest rate swap

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › issues with interest rate swap

  • This topic has 7 replies, 3 voices, and was last updated 10 years ago by John Moffat.
Viewing 8 posts - 1 through 8 (of 8 total)
  • Author
    Posts
  • November 26, 2014 at 7:50 am #213293
    questforknowledge
    Member
    • Topics: 29
    • Replies: 47
    • ☆☆

    Good morning John, i have come with an extract of the June 2014 question oneb on interest rate swap. this is an area that i dont really understand what is happening even after going through the solution i don’t understand it below is an extract
    CMC will take a four-year CHF60,000,000 to part-fund the setting up of four branches. Interest will be payable on the loan at a fixed annual rate of 2·2% or a floating annual rate based on the yield curve rate plus 0·40%. The loan’s principal amount will be repayable in full at the end of the fourth year.
    Pecunia Bank is willing to offer an interest rate swap contract with a counterparty, where the counterparty can borrow at an annual floating rate
    based on the yield curve rate plus 0·8% or an annual fixed rate of 3·8%. Pecunia Bank would charge a fee of 20 basis points each to act as the intermediary of the swap. Both parties will benefit equally from the swap
    contract.
    Required
    Demonstrate how CMC Co could benefit from the swap offered by Pecunia Bank.
    the solution talks of comparative advantage, the net result figure. i don’t seem to understand what is going on. please i need help in this area
    thank you

    November 26, 2014 at 10:53 am #213382
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    Have you tried doing what I did in my previous answer to you?!
    You do exactly the same here.

    If CMC borrows floating and other borrows fixed, then the total is (L + 0.4%) + 3.8% = L + 4.2%

    If CMC borrows fixed and the other floating, then the total is 2.2% + (L + 0.8%) = L + 3%

    So by swapping they can same a total of 1.2% before bank fees. The bank charges 2 x 0.2 = 0.4%, so there is still; a net saving to be made.

    November 26, 2014 at 11:08 am #213392
    questforknowledge
    Member
    • Topics: 29
    • Replies: 47
    • ☆☆

    yes John i did try it in the other forum. so if i get you well, by swapping they will save 1.2% and if i then deduct the bank charges of 0.4%, the net gain is 1.2%-0.4% = 0.8% . this will give a net gain to each party of 0.4% since they gain equally. am i right?

    November 26, 2014 at 3:42 pm #213463
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    You are correct 🙂

    November 26, 2014 at 4:10 pm #213484
    questforknowledge
    Member
    • Topics: 29
    • Replies: 47
    • ☆☆

    thank you i think i now have an idea on what is happening. i am ready for the challange come tuesday

    November 26, 2014 at 4:38 pm #213497
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    Good luck 🙂

    April 2, 2015 at 5:48 pm #239939
    Max
    Member
    • Topics: 0
    • Replies: 1
    • ☆

    hi, im having problems with this question as well. can you please help me?

    So after deducting the bank charges of 2X0.2 = 0.4, there is still a savings of 1.2%- 0.4% = 0.8% each party.

    So now, How much CMC and the counterparty has to pay ?

    According to the answer scheme :

    “After paying the 20 basis point fee, CMC Co will effectively pay interest at the yield curve rate and benefit by 40 basis points
    or 0·4%, and the counterparty will pay interest at 3·4% and benefit by 40 basis points or 0·4% as well.”

    how did they get 3.4% and that CMC has to pay at the yield rate?

    April 3, 2015 at 12:29 am #239966
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    In both cases it is the amount they would pay if they did their own borrowing (i.e. no swap) less the 0.% that they are saving.

    (Have you watched the free lecture on interest rate swaps? If not, then I think you will find it helpful)

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