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Hi Sir
a very humble requesti tried hard to learn the concepts myself. i shall be very thankful if u check my calculations based on my concepts. and correct me if i am wrong.
if bank pay at floating and keshi pay at fix
decreased LIBOR 3.3 increased LIBOR 4.3
LIBOR + .4 (666) (846)
Recieved LIBOR+.3 648 828
Payment 4.6% (828) (828)
fee 10 basis (18) (18)net (864) (864)
effective interest . 864/18000= 4.8% . LIBOR increase and decrease doesnot effect liability as impact is netted off with the floating rate.
if Bank paid at fixed and keshi at floating
fixed 5.5 (990) (990)
paymentLIBOR +.3 (648) (846)
recieved at 4.6 828 828
fee 10 basis (18) (18)net 828 1026
effective interest 4.6 5.7
so keshi should go for first option as with the increase in LIBOR effective interest rate remain the same as compared to second option
You can find a full explanation of the swap in Keshi here:
https://opentuition.com/topic/keshi-co-1214-part-a-swap/Have you watched my free lecture on swaps?
Hello,
Please , I don’t understand why Keshi should choose fixed over floating rate since Keshi is anticipating interest rate to increase or decrease by 0.5%.
They are expecting to borrow so they’re hedging against a rising interest rate. So
at worst if interest rate increases it’ll be 4.3% (3.80%+0.50%) which is better than 5.04%. But if Keshi chooses Variable rate it is L-0.06% , that is whatever LIBOR rate is Keshi will go below LIBOR by 60 basis point. And they’re anticipating LIBOR to only increase by 0.50% to 4.3%( Less than 5.04%). And the question doesn’t tell Keshi prefers Fixed.
I’m a little confused.Two things.
Firstly, there is uncertainty over the future interest rate and any uncertainty creates a risk. Borrowing at fixed rate removes that risk and means that they can budget with confidence. One of the roles of the treasury department is stated as being to manage risk.
Secondly, although this question does not specifically state whether they want to end up paying fixed of floating (which is unusual), a swap can only benefit one way round. Here there is only a net benefit if they swap the way in the answer (if they swapped the other way round there would not be a saving).
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