FINA 4110 Slides 7 [Swaps]

FINA 4110 Slides 7 [Swaps] - Swaps Chapter 7 1 Nature of...

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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 z 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 z Next slide illustrates cash flows 3
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Cash Flows to Microsoft (See Table 7.1, page 159 ---------Millions of Dollars--------- LIBOR FLOATING FIXED Net Date Rate Cash Flow Cash Flow Cash Flow Mar.5, 2010 4.2% Sept. 5, 2010 4.8% +2.10 –2.50 –0.40 Mar.5, 2011 5.3% +2.40 –2.50 –0.10 Sept. 5, 2011 5.5% +2.65 –2.50 +0.15 Mar.5, 2012 5.6% +2.75 –2.50 +0.25 Sept. 5, 2012 5.9% +2.80 –2.50 +0.30 Mar.5, 2013 6.4% +2.95 –2.50 +0.45 4
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Typical Uses of an Interest Rate Swap z Converting a liability from z fixed rate to floating rate z floating rate to fixed rate z Converting an investment from z fixed rate to floating rate z floating rate to fixed rate 5
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Intel and Microsoft (MS) Transform a Liability (Figure 7.2, page 160) 5% Intel MS LIBOR+0.1% 5.2% LIBOR 6
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Financial Institution is Involved (Figure 7.4, page 162) 4.985% 5.015% F.I. 5.2% Intel LIBOR LIBOR+0.1% MS LIBOR 7
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Intel and Microsoft (MS) Transform an Asset (Figure 7.3, page 161) 5% Intel MS LIBOR-0.2% 4.7% LIBOR 8
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Financial Institution is Involved (See Figure 7.5, page 163) 4.985% 5.015% Intel F.I. 4.7% MS LIBOR LIBOR-0.2% LIBOR 9
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Quotes By a Swap Market Maker (Table 7.3, page 163) 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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The Comparative Advantage Argument (Table 7.4, page 166) z AAACorp wants to borrow floating z BBBCorp wants to borrow fixed Fixed Floating AAACorp 4.00% 6-month LIBOR 0.1% BBBCorp 5.20% 6-month LIBOR + 0.6% 11
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The Swap (Figure 7.6, page 166) 4.35% 4% AAACorp BBBCorp LIBOR+0.6% LIBOR 12
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The Swap when a Financial Institution is Involved (Figure 7.7, page 167) AAA F.I. BBB LIBOR 4.33% LIBOR LIBOR+0.6% 4.37% 4% 13
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FINA 4110 Slides 7 [Swaps] - Swaps Chapter 7 1 Nature of...

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