The document contains 4 questions regarding interest rate swaps between companies. 1. A firm had entered a swap paying 9% fixed and receiving a floating rate. With rates changing, the firm wants to cancel the swap and should ask for a payment of Rs. 15.15 lakhs. 2. Two companies enter a swap so company Y can borrow at floating LIBOR rate while company X borrows at a fixed 9% rate. 3. Two companies and a bank all benefit from a swap that allows each to pay a rate better matching their preferred fixed or floating rate. 4. Two foreign companies and a bank also benefit from a currency and interest rate swap to allow each company to borrow

1. Name of the Teacher: Gayathri Ravikumar
Department: Commerce PG.
1. A firm had entered into a swap arrangement for a notional principal of ` 1 crore
with a bank where the bank paid 9% fixed and received MIB0R semi annually. It
has 3 more years to go and has just exchanged the cash flow. The 6-month MIBOR
for the next payment of interest was reset at 8%. Next day the markets exhibited a
fall and the 6-month MIBOR fell to 7%s, leading the firm to believe that it is
overpaying. It wants to cancel the swap arrangement. How much should the firm
ask the bank to pay to cancel the swap deal?
Solution
The value of the swap for the firm is determined on the basis of discounted cash flows. Since
the rates have changed the discount rate used would be 7%; the prevalent market rate. The
value of the cash outflows on the fixed basis discounted at 7% is ` 115.63 (shown below)
Fixed leg payment – 9.00%
Cash outflow Present 12-month MIBOR-7.00%
Next Interest payment on floating rate -8.00%
The present value of the inflow at floating rate would be next interest, payment known
decided a period in advance plus face value of ` 100 discounted at 7/a. This amount works out
to ` 100.48
Subject/Paper Financial Derivatives-5
Class M.com
Year II/SEM IV
Date 30/04/2020
Class Time 10:00-11:00am
Unit IV
Topic
Interest Rate Swaps problems and solution

2. Value of Floating Leg
Interest to be received after 6-rn 4.00
Principal to be received after 6-m 100.00
104.00
Present Value at 7.00% 100.48
The present value of the cash outflow is more by ` 15.15 for a principal of ` 100. If the bank
pays ` 15.15 lakh for the principal amount of ` 1 crore, the firm may exit the swap.
2. Suppose two companies X and Y want to borrow Rs. 12 crore for 6 years. The
company Y wishes to arrange a floating loan. The interest in LIBOR semi-annually
paid. The following are terms and condition
SOULTION :
The company X borrows at fixed rate of 9%, the company Y borrows at floating rate of
(LIBOR + 0.25%). They enter into a swap agreement.

3. 3. Companies A & B have been offered the following rates per annum on a $20
million five-year plan.
Solution:
Company 'A' requires floating rate loan. Where as Company 'B' requires fixed rate loan.
But in reality;
Company A has an advantage in fixed rate as well as in floating rate.
But in fixed rate advantage =(6.5 – 5)%=1.5%
In floating rate advantage= (LIBOR + 1 – LIBOR – 0.5)% = 0.5%
So, Company A has comparative advantage in fixed rate.

4. For this, "A" searches for a counter party, who has a comparative advantage in floating rate,
that is only possible through an intermediary (banks) than only swap deal occurs.
Before the deal, Company "A" paid floating rate interest LIBOR+0.5%
But after the deal, paid by company LIBOR+0.2%
So, total gain =>LIBOR+0.5% - LIBOR - 0.2%=0.3%
Before the deal Company B paid fixed rate interest 6.5%
But after the deal, interest paid by company 6.2%
So, total gain =>6.5% - 6.2%=0.3%
For the bank, gain in fixed rate=>(6.2 - 5)%=1.2%
Gain in floating rate=>LIBOR+0.2% - LIBOR - 1%=(-)0.8%
Total Gain of Bank=1.2% - 0.8%=0.4%

5. 4. Company A, a British manufacturer, wishes to borrow US dollars at a fixed rate of
interest. Company B, a US multinational, wishes to borrow sterling at a fixed rate
of interest. They have been quoted the following rates per annum (adjusted for
differential tax effects).
Solution:
Company "A" wishes to borrow US dollars
Company "B" wishes to borrow Sterling
But Company B has competitive advantage in both (Sterling & US dollars).
In Sterling advantage is = (11.0 – 10.6) % = 0.4%
In US dollars advantage is = (7.0 – 6.2) % = 0.8%
So, Company B has competitive advantage in US$, but he wants to borrow Sterling.
Therefore B wants a counter party who has competitive advantage in sterling, but really wants
US dollars. So he gets Company A, both go for swap deal with the help of a financial

6. institution.
For Company A:
Before the deal Company A gives 7% US $
But after the swap deal he gives 6.85% US $
So Gain for A=>(7 – 6.85)%=0.15% US $
For Company B:
Before the deal, company B gives 10.6% sterling
But after swap deal he gives 10.45% sterling
So Gain for B = (10.6 – 10.45) % = 0.15% sterling
For Financial Institution:
In US dollar gain = (6.85 – 6.2)%=0.65%
In sterling gain = (10.45 – 11.0)% = (–) 0.55% sterling
Net Gain = (0.65 – 0.55)% = 0.10%