Interest Rate Swaps(IRS) is a reference tofinancial instruments knownas hedgesand derivatives.To hedge somethingis to evade or “dodge”something.
When you hedge your bets youare insuring yourself againstlosing.In essence that is whatan interest rate swapis; it is a hedge againstthe movement ofinterest rates.
In its most basic form there isa vanilla interest rate swap.Like all interest rateswaps, you “swap” interestrates with the provider of theinterest rate swap.
One party (you, known ascounterparty A) will pay a fixedrate.Counterpart B(the bank) will pay avariable rate.
When interest rates (either Bank ofEngland base rate, your lendingbank’s base rate or LIBOR) go abovea predetermined Level CounterpartyB(the bank) pays Counterparty A(you) money.
When the rate fall below thislevel Counterparty A willpay Counterparty B.
The financial effect of this is thatyou will have a fixed rate.If interest rates increase above theset rate the amountspayable under the loanwill increase, but thebank will compensateyou for it.
If the interest rates fall below the setrate the amounts payable under theloan will fall but youwill make up thedifference by payingthe bank under theswap.
The net off-set ofpayments meansthat you will alwayshave the samecontingent liabilityfor the repaymentsunder the underlyingloan facility andswap.
Interest rate swapping can then beused in a many ways, limited onlyby the imagination.
For a capped rate a ceiling limit willbe set. Counterparty A can thenbenefit from interest ratesfluctuating, but will never payabove the set rate.
That gives the abilityto enjoy ratesdropping, but alwaysknowing that you willnever pay above acertain set interestrate.
There can be a cap and afloor, meaning that Counterparty Acan know for certain that they willonly pay a variable rate within setparameters.
The interest rate can be set using avariety of indicators including, butnot limited to LIBOR (the London Inter-Bank Offered Rate),Bank of Englandbase rate and theLending bank’s base rate.
Hedging can be very beneficial toa business when usedappropriately.However, they are very complexfinancial instruments.
Choosing the right level to set therates means finding the perfectbalance.
If the rate is set wrong aproduct designed tohelp the business canlead to, at worst, theinsolvency of thatbusiness.
What the banks andbusinesses alike did notappreciate before 2008was that interest rateswould drop to 0.5%.
It certainly could not have beenappreciated by anyone thatinterest rates would remain at0.5% for so long, and no-onecould have predicted the currentpossibility of a furtherdrop to 0.25%.
A feature of some of the swaps isthat if the set rate fell below aspecified point, say 3%, thenCounter party A would pay Counterparty B additional sums.This came as a surpriseto the parties subjectto these strictures.
While the rest of the countrybenefited from cheaper lendingfacilities businesses subject to thesekinds of swaps were being crippledby increased payments.
Their businesses had been hit hardby the deep recession but thenfound that their cash flow wastaken up paying money to thebank under the swap.
Whilst business was indecline, those who werebound by swap agreementswere having to payincreased outgoings to theirbanks.
As stated, “interest rate swaps” is aterm used to cover all swaps.There are also LIBORswaps, knock in floor,caps, structured collars,debt default swaps,foreign currency swapsand many more.
If you have any kindof swapagreement, we canassist you.
We have found that as a result of thefall in currency levels clientssubjected to foreign currency swapshave been unable to compete in themarket because they are fixedin to a set currencyexchange rate, but thecost of exiting theSwap is large.
Contact Rate Swap Refundstoday for a no obligationdiscussion, regardless the formof swap you have.
RATE SWAP REFUNDCALL OUR OFFICE NOW!( FROM A FREE LANDLINE PHONE)0845 567 3002