SWAPS. Dr. Rana Singh Associate Professor www.ranasingh.org. Swaps – An agreement between two companies to exchange cash flows in the future. Hedging Instruments. Rupee Interest Rate Swaps (IRS) Nature: Contract for exchange of a fixed to floating,or floating to floating rates of interest
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Dr. Rana Singh
Swaps – An agreement between two companies to exchange cash flows in the future.
An interest rate swap is a contract which
commits two counter-parties to exchange,
over an agreed period,
two streams of interest payments,
each calculated using a different index,
but applied to a common notional principal
6 months 8.00 7.75
1 year 9.25 8.75
2 years 9.85 9.35
3 years 10.25 9.50
For a 1 year swap, the swap dealer is willing to receive 9.25% fixed, and pay 8.75% fixed, earning a spread of 50 bps.
Managing Gaps in Balance Sheet
Assume that 2 companies, XYZ and PQR, can raise funds at the following rates:
Bond market :
XYZ : 11% PQR : 13%
Bank funds :
XYZ : Mibor + 100 bp
PQR : Mibor +175bp
Arbitrage arises from the differing credit spreads in both the markets