Swap Rate

Nb1

Speculative viewpoint:

It is decreased of LIBOR rate below 8%

If flat curve of interest rates, LIBOR rate is equal to the swap rate at a given date.

Date 0:

Swap rate is 8%.

The first LIBOR rate is therefore 8%.

In the future: 10months later

LIBOR is 6.5%

At date 9 months, rate= 7.55%

Rates have decreased => the on-going swap has a positive value. It is possible to cancel the position by signing another swap in opposite direction.

Action should be taken: We sign a forward starting swap starting at date 1Y lasting til date 5y.

We are paying a fixed rate of 6.5%/4.

At point 1Y, Value= (8-7.55)%/4

At point 1.25Y Value= (8-6.5)%/4

Value of the swap: Value of the ‘all’ swap is discounted value of the cash flows.

Remark:

6.5% is quarterly rate.

The yearly compounded rate is larger, (1+0,0065/4)^4 = 1 + 1Y rate (6.66%)

Nb2

Swaps allow for redesigning a debt structure.

Bank: 7coupons2% +principal at maturity

Market-maker:

Information: swap rate is 10%

We add an opposite swap.

PV of 7 payment of 50% interest rate( discount rate) = 10%/4

A bank works like an intermediary between lenders (financial investors who buy and hold products) and borrowers (corporate firms o individuals).

If it is possible to swap cash flows generated by loans and products, the bank takes no risk related to interest rate.

The remaining risk is related to credit.

Borrowers are rated by the bank “scoring”.

Financial investors are very sensitive to the rating of the bank.

Organized market Vs Credit market Vs OTC market

Nb4

 Issuer pays 100M. Borrower pays LIBOR +20bp.

 Issuer pays K (swap rate for 3 years)-10bp.

Financial Investors pay 100M.

=>

Sign a swap.

Issuer pays libor +5bp

Swap market maker pays K .