ACCAspaceaccaspace.com/upload/ACCA_P4/PPT/P4_Chapter_20_Caps...ACCAspace 中国ACCA特许公认会计师教育平台 Copyright © ACCAspace.com 21 3.Using the yield curve and FRA rates

ACCAspace

Provided by ACCA Research Institute

Copyright © ACCAspace.com ACCAspace 中国ACCA特许公认会计师教育平台

ACCA P4

Advanced Financial Management (AFM)

高级财务管理

ACCA Lecturer: Lily Wang

Copyright © ACCAspace.com ACCAspace 中国ACCA特许公认会计师教育平台 2

1

P4 Chapter 20 Content

Caps, floors and collars

2 Interest rate swaps

3 Using the yield curve and FRA rates

to set swap rates


1.Caps, floors and collars

Test your understanding








2. Interest rate swaps

Introduction

• An interest rate swap is an agreement whereby the parties agree

to swap a floating stream of interest payments for a fixed stream

of interest payments and via versa. There is no exchange of

principal:

• The companies involved are termed "counter-parties"

• Swaps can run for up to 30 years

• Swaps can be used to hedge against an adverse movement in

interest rates. Say a company has a$200m floating loan and the

treasurer believes that interest rates are likely to rise over the

next five years. He could enter into a five-year swap with a

counter party to swap into a fixed rate of interest for the next five

years. From year six onwards, the company will once again paya

a floating rate of interest.



Introduction

• A swap can be used to obtain cheaper finance. A swap should

result in a company being able to borrow what they want at a

better rate under a swap arrangement, than borrowing it directly

themselves.



Calculations based on splitting gains

• The precise details of the swap arrangement will depend on how

the potential gains are split between the two counter-parties.

• Illustration : interest rate swap















Calculations involving quoted rates from intermediaries

• In practice a bank normally arranges the swap and will quote the

following:

• The"ask rate" at which the bank is willing to receive a fixed

interest cash flow stram in exchange for paying LIBOR

• The "bid rate" that they are willing to pay in exchange for

receiving LIBOR

• The difference between these gives the bank's profit margin

and is usually at least 2 basis points



Illustration: interest rate swap via an intermediary



Illustration: interest rate swap via an intermediary



Test your understanding: interest rate swap via an intermediary









Further swap example








3.Using the yield curve and FRA rates to set swap ra

tes

In the examples of swap agreements above, the bank agreed to

pay a fixed stream of payments to a company in exchange for a

variable stream of payments made by the company to the bank (or

vice versa)

The bank decides what the fixed payment should be by analysing

the company's yield curve

The key consideration is that at the inception of the swap:

PV of the variable rate payments = PV of the fixed rate payment

When both are discounted at the spot yield.

Notice how, in the illustration below, the calculated swap rate

payment based on the forward interest rates/FRA rates (calculated

earlier in this chapter). This is because the forward rates are our

best estimate of what the actual interest rates might be in the

future.



tes

Illustration



tes

Illustration



tes

Illustration



tes

Illustration



tes

Options over swaps



tes

Summary of terminology

ACCAspace

Provided by ACCA Research Institute

Documents

ACCAspaceaccaspace.com/upload/ACCA_P4/PPT/P4_Chapter_20_Caps...ACCAspace 中国ACCA特许公认会计师教育平台 Copyright © ACCAspace.com 21 3.Using the yield curve and FRA rates