Ch07 - Swaps Chapter 7 1 Nature of Swaps A swap is an...

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Swaps Chapter 7 1
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Nature of Swaps A swap is an agreement to exchange cash flows at specified future times according to certain specified rules 2
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An Example of a “Plain Vanilla” Interest Rate Swap An agreement by Microsoft to receive 6-month LIBOR & pay a fixed rate of 5% per annum every 6 months for 3 years on a notional principal of $100 million Next slide illustrates cash flows that could occur 3
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Cash Flows to Microsoft (See Table 7.1, page 149) 4 ---------Millions of Dollars--------- LIBOR FLOATING FIXED Net Date Rate Cash Flow Cash Flow Cash Flow Mar.5, 2004 4.2% Sept. 5, 2004 4.8% +2.10 –2.50 –0.40 Mar.5, 2005 5.3% +2.40 –2.50 –0.10 Sept. 5, 2005 5.5% +2.65 –2.50 +0.15 Mar.5, 2006 5.6% +2.75 –2.50 +0.25 Sept. 5, 2006 5.9% +2.80 –2.50 +0.30 Mar.5, 2007 6.4% +2.95 –2.50 +0.45
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Typical Uses of an Interest Rate Swap Converting a liability from fixed rate to floating rate  floating rate to fixed rate  Converting an investment from  fixed rate to floating rate floating rate to fixed rate  5
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Intel and Microsoft (MS) Transform a Liability (Figure 7.2, page 150) 6 Intel MS LIBOR 5% LIBOR+0.1% 5.2%
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Financial Institution is Involved (Figure 7.4, page 151) 7 F.I. LIBOR LIBOR LIBOR+0.1 % 4.985% 5.015% 5.2% Intel MS Financial Institution has two offsetting swaps
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Intel and Microsoft (MS) Transform an Asset ( Figure 7.3, page 151) 8 Intel MS LIBOR 5% LIBOR-0.2% 4.7%
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Financial Institution is Involved (See Figure 7.5, page 152) 9 Intel F.I. MS LIBOR LIBOR 4.7% 5.015% 4.985% LIBOR-0.2%
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Quotes By a Swap Market Maker (Table 7.3, page 153) Maturity Bid (%) Offer (%) Swap Rate (%) 2 years 6.03 6.06 6.045 3 years 6.21 6.24 6.225 4 years 6.35 6.39 6.370 5 years 6.47 6.51 6.490 7 years 6.65 6.68 6.665 10 years 6.83 6.87 6.850 10
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(Table 7.4, page 155) AAACorp wants to borrow floating BBBCorp wants to borrow fixed
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Ch07 - Swaps Chapter 7 1 Nature of Swaps A swap is an...

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