5.6 More on table 5.1 The floating- rate payments are calculated using the six-month LIBOR rate prevailing six month before the payment date The principle is only used for the calculation of interest payments. However, the principle itself is not exchanged-Meaning for Notional principle The swap can be regarded as the exchange of a fixed-rate bond for a float -rate bond Company B(A)is long(short)a floating-rate bond and short (long)a fixed-rate bond Options, Futures, and Other Derivatives, 4th edition@ 2000 by John C. Hull Tang Yincai, Shanghai Normal University
Options, Futures, and Other Derivatives, 4th edition © 2000 by John C. Hull Tang Yincai, Shanghai Normal University 5.6 More on Table 5.1 • The floating-rate payments are calculated using the six-month LIBOR rate prevailing six month before the payment date • The principle is only used for the calculation of interest payments. However, the principle itself is not exchanged—Meaning for “Notional principle” • The swap can be regarded as the exchange of a fixed-rate bond for a float-rate bond. Company B (A) is long (short) a floating-rate bond and short (long) a fixed-rate bond
5.7 Typical Uses of an Interest Rate Swap Converting a liability Converting an investment from a from a FIXED rate liability to a FXED rate investment to a 户 LOATING rate liability FLOATING rate investment FLOATING rate liability FLOATING rate investment to a F XED rate liability to a fXed rate investment Options, Futures, and Other Derivatives, 4th edition@ 2000 by John C. Hull Tang Yincai, Shanghai Normal University
Options, Futures, and Other Derivatives, 4th edition © 2000 by John C. Hull Tang Yincai, Shanghai Normal University 5.7 Typical Uses of an Interest Rate Swap • Converting a liability from a – FIXED rate liability to a FLOATING rate liability – FLOATING rate liability to a FIXED rate liability • Converting an investment from a – FIXED rate investment to a FLOATING rate investment – FLOATING rate investment to a FIXED rate investment
58 Transforming a Floating-rate Loan to a Fixed-rate Consider a 3-year swap initialized on March 1, 2000 Where Company B agrees to pay Company A 5%pa on $100 million Company a agrees to pay Company B 6-mth LIBOR on $100 million Suppose Company B has arranged to borrow $100 million LIBOR+ 80bp 5% Company C ompany 5.2% LIBOR B LIBOR+0.8% Note: 1 basis point(bp )= one-hundredth of 1%0 Options, Futures, and Other Derivatives, 4th edition@ 2000 by John C. Hull Tang Yincai, Shanghai Normal University
Options, Futures, and Other Derivatives, 4th edition © 2000 by John C. Hull Tang Yincai, Shanghai Normal University 5.8 Transforming a Floating-rate Loan to a Fixed-rate • Consider a 3-year swap initialized on March 1, 2000 where Company B agrees to pay Company A 5%pa on $100 million Company A agrees to pay Company B 6-mth LIBOR on $100 million • Suppose Company B has arranged to borrow $100 million LIBOR + 80bp Company B Company A 5% 5.2% LIBOR LIBOR+0.8% Note: 1 basis point (bp) = one-hundredth of 1%
5.9 Transforming a Floating-rate Loan to a Fixed-rate (continued) After Company B has entered into the swap, they have 3 sets of cash flows Pays LiBOR plus 0.8% to outside lenders 2. Receives LIBOR from Company a in the swap 3. Pays 5% to Company A in the Swap In essence. b has transformed its variable rate borrowing at LIBOR 80bp to a fixed rate of 5.8% Options, Futures, and Other Derivatives, 4th edition@ 2000 by John C. Hull Tang Yincai, Shanghai Normal University
Options, Futures, and Other Derivatives, 4th edition © 2000 by John C. Hull Tang Yincai, Shanghai Normal University 5.9 Transforming a Floating-rate Loan to a Fixed-rate (continued) • After Company B has entered into the swap, they have 3 sets of cash flows 1. Pays LIBOR plus 0.8% to outside lenders 2. Receives LIBOR from Company A in the swap 3. Pays 5% to Company A in the Swap • In essence, B has transformed its variable rate borrowing at LIBOR + 80bp to a fixed rate of 5.8%
5.10 a and B transform a liability (Figure 5.2, page 125) 5.2 A B LIBOR+0.8% LIBOR Options, Futures, and Other Derivatives, 4th edition@ 2000 by John C. Hull Tang Yincai, Shanghai Normal University
Options, Futures, and Other Derivatives, 4th edition © 2000 by John C. Hull Tang Yincai, Shanghai Normal University 5.10 A and B Transform a Liability (Figure 5.2, page 125) A B LIBOR 5% LIBOR+0.8% 5.2%