PRODUCT TRAINING -FID ANALYST PROGRAMME AUGUST 2000
INTEREST RATE SWAPS
An interest rate swap is an agreement between two parties toexchange a fixed payment for a floating payment.
Company A agrees to pay Company B 8% a year for 5 years on$10 million in return for B paying A 6-month LIBOR on the samesum.The interest rate swap arose in the early 1980s. Banks were happylending to some borrowers who were unable to raise fixed ratefunds through the bond market owing to investor aversion.However, banks were happier lending floating funds. It made sense,therefore for a company who wanted to borrow fixed funds, butwho could not conveniently do so, to find another company whowanted to borrow floating funds. The latter company would issuea fixed rate bond and the former would issue a floating rate note(or else borrow direct from its bankers), and the two companieswould agree to swap.
ABank BLendere.g. bank Lendere.g. bondholderFixedFixedFixedLIBORLIBOR LIBOR