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This is the answer to question c) advantages of swap
Any criticism after the end of the loan period will be based on hindsight. What appeared to be the
cheapest choice at that stage may not have been what appeared most likely to be the cheapest
choice when the loan was taken out.In addition, criticism of the directors for not choosing the
cheapest option fails to consider risk.The cheapest option may be the most risky.The directors may reasonably take the view that the saving in cost is not worth the risks incurred.sir i am not clear what it means and how it is advantageous, pls explain in short?
If they do not enter into the swap then the interest they end up paying will depend on what happens to interest rates in the future. They are uncertain and might increase or obviously might decrease – there is therefore risk.
If they do enter into the swap then they will end up paying fixed interest, whatever happens to interest rates. So the risk is removed – the interest payments are certain.
Obviously if interest rates go up then they will be glad they swapped and ended up paying less interest, but if interest rates go down they will wish that they they had not swapped because they will end up paying more interest. However they will not know this until the end of the four years (i.e. hindsight) – they do not know now what it going to happen.
The main reason for swapping is to remove the risk. They now know for certain what they will be paying and can plan ahead on that basis.
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