Finance 362 2022SC Workshop 4
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Finance 362
2022SC
Workshop 4
Topic 5: Swaps (Part 1)
1. Interest Rate Swaps (IRS)
– to exchange a series of interest payments based on a notional principal.
- Fixed-to-floating (Coupon Swaps)
- Floating-to-floating (Basis Swaps)
- Swaps buyer:
- Swaps seller:
pays RFX & receives RFL
pays RFL & receives RFX
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RQ MCQ2 |
b. Design an IRS
Q: Companies A and B have been offered the following rates per annum on a $20 million three-year bond investment.
Company A
Company B
Fixed Rate
7.00%
11.80%
Floating Rate
LIBOR
LIBOR +1.20%
Company A requires a three-year fixed rate investment. Company B requires a floating-rate investment.
Design an interest rate swap that will provide a Bank acting as an intermediary a 0.6% net margin per annum and split the remaining benefits under the swap as follows:
30% to Company A; and
70% to Company B.
Note: the swap payments and receipts should be LIBOR flat versus some fixed rate.
(a) Complete the diagram below showing the relationship between all the parties. Be sure you clearly label
the interest receipts on the investment by each party, the swap payment and receipt rates and whether the swap payments/receipts are fixed or floating.
(b) What is the effective rate of return to Company A and B on their $20 million investment position after the
interest rate swap transaction?
(c) How much better off in terms of their return on investment are Companies A and B after the swap compared to the outcome if no swap transaction had taken place?
2022-09-02