1) Company A and Company B enter into an interest rate swap agreement where they agree to exchange their interest payment obligations. 2) Company A wants to borrow at a floating rate as it expects rates to decline, while Company B wants a fixed rate as it expects rates to rise. 3) The swap allows Company A to pay a fixed rate of 6.25% while receiving a floating rate, and Company B to pay a floating rate while receiving a fixed rate of 6.25%, benefiting both companies based on their rate expectations.

1. Interest Rate Swaps
WINTER
Course : Financial Instrument-I
Template
Topic 2 DERIVATIVES
Part 3 Types of Derivatives
(4) Interest Rate Swaps

2. Interest Rate Swaps
BW
WINTER
Co. A & Co.Template borrow $
ants to
1,000,000
Company - A Company - B
Expects Interest rate to Decline. Expects Interest rate to Rise.
Thus, Wants to borrow at FLOATING RATE. Thus, Wants to borrow at FIXED RATE.

3. Company - A
Fixed Rate
Base Rate

4. Company - B
Base Rate
Fixed Rate

5. Interest Rate Swaps 01
Scenario 1 :
WINTER
Template
Co. A & Co. B Wants to borrow $
1,000,000
Company - A Company - B
Expects Interest rate to Decline. Expects Interest rate to Rise.
Thus, Wants to borrow at FLOATING RATE. Thus, Wants to borrow at FIXED RATE.

6. Rates Applicable 02
Company - A Company - B
Credit Rating AA B
Fixed 6% Fixed 8%
Rate Rate
Floating LIBOR +1 % Floating LIBOR +1.5 %
Rate Rate

7. Swap Ar r angement 04
Company - A Company - B
Libor + 0.5 %
Fixed 6.25 %
Net Adjustment at month’s End.
Fixed 6%
Rate
Floating rate LIBOR + 1% Floating LIBOR +1.5 %
Rate
Bor r ow $ 1, 000, 000

8. Swap Ar r angement 04
Company - A Company - B
Libor + 0.5
%
Fixed 6.25 %
Fixed 6%
Rate
Floating LIBOR +1.5 %
Rate

9. Swap Ar r angement 04
Company - A Company - B
Libor + 0.5
%
Fixed 6.25 %
Fixed 6%
Rate
Floating LIBOR +1.5 %
Rate

10. Swap Ar r angement 04
Company - A Company - B
Fixed 6.25 %
Fixed 6%
Rate
Fixed Rate 0.25 % Net Gain

11. Swap Ar r angement 04
Company - A Company - B
Libor + 0.5 %
Fixed 6.25 %
Fixed 6%
Rate
Floating LIBOR +1 % Floating LIBOR +1.5 %
Rate Rate
Fixed Rate 0.25 % Net Gain

12. Swap Ar r angement 04
Company - A Company - B
Fixed 6.25 %
Fixed 6% Fixed Rate 8%
Rate
Floating LIBOR +1 %
Rate
Net Gain Fixed Rate 1.75 %

13. Swap Ar r angement 04
Company - A Company - B
Libor + 0.5 %
Fixed 6.25 %
Fixed 6% Fixed Rate 8%
Rate
Floating LIBOR +1 % Floating rate LIBOR +
Rate 1.5%
Net Gain Fixed Rate 1.75 %

14. Swap Ef f ect 05
Company - A Company - B
Libor + 0.5 %
Fixed 6.25 %
Fixed 6% Fixed Rate 8%
Rate
Floating LIBOR +1 % Floating rate LIBOR +
Rate 1.5%
Fixed Rate 0.25 % Net Gain Fixed Rate 1.75 %

15. Swap Ef f ect 05
Company - A Company - B
Libor + 0.5 %
Fixed 6.25 %