• A company enters into an interest rate swap where it is paying fixed and receiving LIBOR. When interest rates increase, which of the following is true?
• The value of the swap to the company increases
• The value of the swap to the company decreases
• The value of the swap can either increase or decrease
• The value of the swap does not change providing the swap rate remains the same
• A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap?
• 2.4%
• 2.7%
• 3.0%
• 3.3%
• You are an interest rate swap trader at a bank and your client has requested swapping fixed for floating. They currently borrow at 1.60% fixed for 3 years.
What floating rate could they swap into if your price in the 3-year swap is
1.45 – 1.46?
• A corporate enters into an interest rate swap with a bank where they exchange 2-year fix at 1.50% for floating (6-month Libor) on $10,000,000 nominal.
Show the cash flows if 6-month Libor fixes at 1.5% for the first year and 2% for the second year.
Has the corporate made or lost money by the end of the 2 years?
• Give four reasons why the interest rate swap market is such a large and popular derivative market
• List three risks involved in trading interest rate swaps.
Answer:
a) 1.60 – 1.45 = Libor + 15 bps
b) CF1 -75k +75k 0 net
CF2 -75k +75k 0 net
CF3 -75k +100k 25k net
CF4 -75k +100k 25k net
Total 50k profit because Libor rates rose, and swap received floating
c) Liquid, cheap, efficient, no exchange of principal, flexible OTC structure, matches hedging needs
d) credit /counterparty risk, clearing, collateral, interest rate risk.