Finance

BUSN 7240 | August 7

2012

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[Type the abstract of the document here. The abstract is typically a short summary of the contents of the document. Type the abstract of the document here. The abstract is typically a short summary of the contents of the document.] | FINANCE |

ANSWER 1

The interest rate swap markets have become an extensive means for hedging the investments made by the investors. The swap gives the benefit to the party entering into the contract to enter into another agreement with the same or even the different party if the situation arises going into the future. The swap basically gives the flexibility regarding the affect of contract being entered and if the investor wishes so, he can terminate it before the expiration of the contract. Thus the flexibility regarding the termination of swap is the most important advantage being offered by the interest rate swaps.

An interest rate swap is one in which the exchange of interest amount takes place between the parties for a fixed notional amount. The original amount of principal is not exchanged and only the interest component is exchanged by the parties. The basic feature of the interest rate swap is the fact that one party pays a fixed amount of interest assuming the fact that the interest payments may increase going into the future and thus by making fixed payments for the cash flow, he is going to escape the burden of heavy payments of interest going into the future. The other party pays floating rate interest that is the interest on LIBOR rates which indicates that the amount of interest keeps on fluctuating in the economy and depends on the interest rate but the advantage being if the rates come down drastically in the future, the interest payment gets reduced.

The advantages of using interest rate swaps are:-

1. The difference between efficiency in markets is properly captured by entering into a swap as the party having conviction on the direction of the interest rates can move into the...