interestrateswapssound2-140515125515-phpapp01.pptx

PPT on interest rate SWAP

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2. 2 A swap is the situation where 2 companies borrow money. They pay each others interest and by doing this they save money

3. IRS EXAMPLE company A is a large company, asset backed. It wants to borrow $1M . bank tells it, it can borrow floating rate at LIBOR +20 or fixed rate at 5.40%. the company thinks that interest rate may go up and choose fixed interest rate company B is a consulting group. It has a long history of profits and has a good credit rating. It wants to borrow $1m. The bank tells company B it can borrow at LIBOR + 80 or fixed 5%. the company thinks that interest rate may get down and choose floating interest rate The investment bank offers to organize an interest rate swap for a fee jointly payable from interest payments. now the investment banks tells the company A to get that loan for floating at LIBOR + 20 and company B for fixed at 5%

4. The word basis in the term basis point comes from the base move between two percentages, or the spread between two interest rates. Since the changes recorded are usually narrow, and because small changes can have outsized outcomes, the basis is a fraction of a percent. BPs

5. Interest rate offered by the lender Floating Fixed % Company A LIBOR +20 5 .40 Company B LIBOR+ 80 5 Floating Fixed % Company A LIBOR +20 5 .20 (IRS) Company B LIBOR+ 50 (IRS) 5 Interest rate swap agreement organized by the investment banks

6. LIBOR LIBOR is  the benchmark interest rate at which major global banks lend to one another . LIBOR is administered by the Intercontinental Exchange, which asks major global banks how much they would charge other banks for short-term loans The London Interbank Offered Rate (LIBOR) is meant to reflect the average interest rate major banks charge each other to borrow. LIBOR is normally published at  11:55 am London time on each applicable London business day  for all applicable currencies and tenors, except as described below. There is no LIBOR publication in any currency or tenor if the date is a London public holiday.

7. Other Benchmark Interest Rate Secured Overnight Funding Rate (SOFR) Federal Funds Rate Ameribor Bloomberg Short-Term Bank Yield (BSBY) Index SONIA ( Sterling Overnight Index Average )

8. Example of interest Rate S waps Company B Investment Bank Company A 5% LIBOR+20 LIBOR+ 50 LIBOR+ 40 5. 20 % 5. 10 % Lender bank Lender bank

9. Interest Rate SWAPS Current situation for company A is that it is receiving libor + 40 basis points and it paying only libor + 20 basis point to the lender. current situation for company B is that it is receiving 5.10% of fixed interest where it wants to pay only 5%.

10. Risks of Interest Rate S waps Floating rate risk Actual interest rate movements do not always match expectations. Default risk This is the risk that the other party in the contract will default on its responsibility.

11. Basis swap A  basis swap  is an  interest rate swap  which involves the exchange of two floating rate  financial instruments. A basis swap functions as a floating-floating interest rate swap under which the floating rate payments are referenced to different bases.

12. E xample A company lends money to individuals at a variable rate that is tied to the  London Interbank Offered Rate (LIBOR), but they borrow money based on the  Treasury Bill  (T-Bill) rate. This difference between the borrowing and lending rates (the spread) leads to interest rate risk, which refers to the potential that a change in interest rates could lead to investment losses. By entering into a basis rate swap—where the company exchanges the T-Bill rate for the LIBOR rate—the company eliminates this  interest rate risk .

13. Primary reasons why financial institutions use interest rate swaps H edge against losses Manage credit risk Speculate