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Dear Sir,
in both questions there is a borrowing involved.
However I cannot find an easy way to understand why in Q1 Jun Cocoa is taking fixed rate at the beginning and in Q2 Dec Kenshi is taking floating one at the start.
Shouldn’t it be similar?How can we know when approaching such questions whether to start with floating or fixed?
I thought somehow that if there is a borrowing then there is always a fear of interest rise so I’d better have a fixed rate. In Q2 Kenshi finishes with 5,04% after fee and in Q1 Cocoa with Yield – 0,04% after fee. So can’t get a pattern…What is more answer for Q1 June says that CMC has comparative advantage in borrowing at the fixed rate and counter has comp. adv. in borrowing at floating. How come? CMC 2,2% Counterparty 3,8% first part I agree. CMC YR+0,4%, Counterparty YR+0,8%. So how counter has advantage if it pays more than CMC for floating?
Thank you in advance much much up to the sky!
MatHave you watched my free lectures on swaps?
Unless the question specifically says that one party wants to end up with fixed (or floating), then it is a question of looking at the two alternative end results and seeing which of the two gives a total overall interest saving.
Please do watch my lecture 🙂
Thank you for the answer.
Yes, I watched, however still confuses me this topic.
When you say look at 2 alternative end results, do you mean result connected with total 1,2% saving or result like YR-0,2% CMC and 3,2% for counterparty before fees?
All I just don’t get it is that when I approach the question, I know how to get to 1,2% total saving, I can do split 0,6 for each.
But since question doesn’t say specifically what the any party wants, I don’t know how to start the part with: CMC borrows, Counter pays, swap etc.
They start in the answer with CMC borrows at 2.2 and Counter at YR+0,8. Don’t know why?
Why they didn’t start with CMC borrows YR+0,4 and counter at 3,8% or at least if I understand you correctly why in answer they didn’t show those 2 alternative end results and say like “this result seems better so let’s start with CMC borrows, Counter pays… and so on and so on”. It’s not clear enough or I am simply a child in the mist 🙂Thank you in advance.
If CMC were to borrow fixed they would pay 2.2% and swap with a counterparty paying
L + 0.8%, so a total of L + 3%.If, on the other hand, CMC were to borrow floating they would pay L + 0.4% and swap with a counterparty paying 3.8%, so a total of L + 4.2%.
So the way to make the saving of 1.2% is for them to go for the first option and swap.
So CMC would end up paying floating interest and the counterpart would end up paying fixed interest, and (after settling up between each other to share the saving) both parties would end up paying less interest than if they had borrowed directly and not swapped.It may help you to watch my lecture working through the whole of this question. You can find it linked from ‘Revision Kit Live’ on the main AFM page.
You are the magician Sir!
This L+3% and L+4,2% thing got straight to the undiscovered potential of my mind and I quickly understood and I will know now how to apply that in those questions 😉
Now I can say I understand swaps.
Quick advice to others:
1. Get the understanding and method how to calculate the total benefit for both parties and when it’s split.
2. Get the understanding of what we have to borrow and what counter borrows (and this Mr. Moffat excellently stated in this post)
3. Remember about balancing figures when going down with numbers after swap to the end result.
4. Check at the end if what you got is right with calculated advance at the beginning.
5. If everything is right, get a chocolate for yourself and Mr. Moffat 🙂
Thank You Sir!
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