Interest Rate

Swap
Swap is an agreement between two parties,
called Counterparties, who exchange future cash
flows over a period of time based on market
Interest Rate Swaps
Commodity Swap
Currency Swaps and more

A commodity producer wishes to fix his income

and would agree to pay the market price to a
financial institution, in return for receiving fixed
payments for the commodity.
Mitigate Price Risk
Lower Progressive Tax
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Interest Rate Swap

Swap Terminolog
Long Swap (Buyer)
Counterparty that receives variable/floating cash
flow
Short Swap (Seller)
Counterparty that is paying variable/floating
Buyer
Seller
cash
flow
Fixed
Floatin
g
to
Fixed

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Party-A
Payer

Party-B
Receiver

to
Floatin
g

Payer counterparty that pays fixed

rate.
Receiver counterparty that receives
Interest Rate Swap
fixed rate.

Swap
Terminology
Day count convention (Yield basis) determines how
interest accrues over time period (Actual/360 float, 30/360
fixed).
ISDA - International Swaps and Derivatives Association, Inc.
Notional principal amount on which the periodic payment
of cash flow is calculated.
Payment period interest calculation period and cash
exchanged at the end of the period.
Rate fixing normally done 2 days before start of period.
Tenor Maturity of the swap

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Interest Rate Swap

Comparative
Advantage
Apple Inc wants to borrow at floating rate and
Boeing Co wants to borrow at fixed rate, under
following
borrowing rates.
Counterparty
FIXED RATE
FLOATING
RATE
APPLE INC

6.25%

LIBOR + 1.11%

BOEING CO

7.66%

LIBOR + 2.34%

Difference

1.41%

1.23%

Apple has relative advantage in fixed market and

Boeing has relative advantage in floating market.
The total arbitrage gain by entering into a swap
deal would be 1.41% - 1.23% = 0.18%
Design a swap where the gain are equally shared
between the 2 companies and the swap dealer.
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Interest Rate Swap

Comparative Advantage
Calculation
gained 6 bps

gained 6 bps
LIBOR

gained 6 bps
LIBOR

Boeing

Apple

Net 7.60%

Net L+1.05

5.26%
LIBOR + 2.34%

5.20%
6.25%

Both counterparties gained 6 bps by borrowing

in their preferred market where they have
comparative advantage.
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Interest Rate Swap

Counterparty
Report

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Interest Rate Swap