1. SWAPS

2. Interest Rate Swap Quotations
Euro-€
£ Sterling
Swiss franc
U.S. $
Bid
Ask
1 year
2.34
2.37
5.21
5.22
0.92
0.98
3.54
3.57
2 year
2.62
2.65
5.14
5.18
1.23
1.31
3.90
3.94
3 year
2.86
2.89
5.13
5.17
1.50
1.58
4.11
4.13
4 year
3.06
3.09
5.12
1.73
1.81
4.25
4.28
5 year
3.23
3.26
5.11
5.16
1.93
2.01
4.37
4.39
6 year
3.38
3.41
2.10
2.18
4.46
4.50
7 year
3.52
3.55
5.10
5.15
2.25
2.33
4.55
4.58
8 year
3.63
3.66
2.45
4.62
4.66
9 year
3.74
3.77
5.09
4.48
2.56
4.70
4.72
10 year
3.82
3.85
5.08
2.64
4.75
4.79
3.82–3.85 means the swap bank will pay fixed-rate euro payments at 3.82% against receiving euro LIBOR or it will receive fixed-rate euro payments at 3.85% against receiving euro LIBOR
Financial Times March 4, 2005

3. An Example of an Interest Rate Swap
Consider this example of a “plain vanilla” interest rate swap.
Bank A is a AAA-rated international bank located in the U.K. and wishes to raise $10,000,000 to finance floating-rate Eurodollar loans.
Bank A is considering issuing 5-year fixed-rate Eurodollar bonds at 10 percent.
It would make more sense to for the bank to issue floating-rate notes at LIBOR to finance floating-rate Eurodollar loans.
Want to get in floating rate

4. An Example of an Interest Rate Swap
Firm B is a BBB-rated U.S. company. It needs $10,000,000 to finance an investment with a five-year economic life.
Firm B is considering issuing 5-year fixed-rate Eurodollar bonds at percent.
Alternatively, firm B can raise the money by issuing 5-year floating-rate notes at LIBOR + ½ percent.
Firm B would prefer to borrow at a fixed rate.
Want to get in fixed rate

5. An Example of an Interest Rate Swap
The borrowing opportunities of the two firms are:

6. An Example of an Interest Rate Swap
The swap bank makes this offer to Bank A: You pay LIBOR – 1/8 % per year on $10 million for 5 years and we will pay you 10 3/8% on $10 million for 5 years
Swap
Bank
10 3/8%
LIBOR – 1/8%
Bank A

7. An Example of an Interest Rate Swap
½% of $10,000,000 = $50,000. That’s quite a cost savings per year for 5 years.
Here’s what’s in it for Bank A: They can borrow externally at 10% fixed and have a net borrowing position of
-10 3/ (LIBOR – 1/8) =
LIBOR – ½ % which is ½ % better than they can borrow floating without a swap.
Swap
Bank
10 3/8%
LIBOR – 1/8%
Bank A
10%

8. An Example of an Interest Rate Swap
The swap bank makes this offer to company B: You pay us 10½% per year on $10 million for 5 years and we will pay you LIBOR – ¼ % per year on $10 million for 5 years.
Swap
Bank
10 ½%
LIBOR – ¼%
Company B

9. An Example of an Interest Rate Swap
½ % of $10,000,000 = $50,000 that’s quite a cost savings per year for 5 years.
Here’s what’s in it for B:
Swap
Bank
10 ½%
They can borrow externally at
LIBOR + ½ % and have a net
borrowing position of
10½ + (LIBOR + ½ ) - (LIBOR - ¼ ) = 11.25% which is ½% better than they can borrow floating.
LIBOR – ¼%
Company B
LIBOR + ½%
11.75
10.50
1.25
0.75
------
.50

10. An Example of an Interest Rate Swap
¼% of $10 million = $25,000 per year for 5 years.
The swap bank makes money too.
Swap
Bank
10 3/8%
10 ½%
LIBOR – 1/8%
LIBOR – ¼%
Bank A
Company B
LIBOR – 1/8 – [LIBOR – ¼ ]= 1/8
10 ½ /8 = 1/8

11. An Example of an Interest Rate Swap
The swap bank makes ¼%
Swap
Bank
10 3/8%
10 ½%
LIBOR – 1/8%
LIBOR – ¼%
Bank A
Company B
A saves ½%
B saves ½%