Interest Rates | Interest-Rate Swaps
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Interest Rates | Interest-Rate Swaps
Interest-Rate Swaps
“My real estate company financed a major project with a rollover credit. The framework agreement is to run for another four years. Since interest rates could rise, I would like to convert the variable-interest commitment into a fixed one. Can I do this?”
For this situation, Credit Suisse will offer you an interest-rate swap that converts the variable-interest commitment into a fixed one. After the conclusion of this transaction, you pay the fixed-interest rate and the bank pays the variable interest rate. With the variable payments made by the bank you offset your interest payments for the loan. This means that your company only has to pay the fixed-loan costs plus the credit margin on the rollover loan. The interest-rate swap is an exchange of interest payments on the basis of fixed or variable interest rates. Only interest payments are exchanged and not capital amounts. The capital is only used as the basis of calculation for the exchange of the interest amount. The minimum amount for interest-rate swaps is CHF 5 million. A precondition for concluding such a transaction is a credit limit and a framework agreement for derivative transactions. For the reasons mentioned above, the risk of this transaction is restricted to the danger that interest rates might change. Consequently, only between 5 % and 10 % of the credit amount is charged against the credit limit, depending on the term and currency. An interest-rate swap is a transaction in one currency. It can be used to convert shortterm and therefore variable interest flows (basis usually 3-month or 6-month LIBOR) into longer-term, fixed-interest flows of from 1 to 10 years duration (fixed-rate payers). It is also possible to make the conversion in the opposite direction (fixed-rate receivers). Example of fixed-rate payers:
Client Hitherto: Rollover credit In addition: Interest rate swap pays variable rate of interest (6-month LIBOR) to receives variable interest rate (6-month LIBOR) from pays fixed interest rate to
Credit Suisse
Example of fixed-rate receivers:
Client Hitherto: Fixed credit In addition: Interest rate swap pays fixed interest rate to Credit Suisse receives fixed interest rate from pays variable interest rate (6-month LIBOR) to
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Interest Rates | Interest-Rate Swaps
Existing interest exposures can subsequently be converted into different interest commitments – e.g. a rollover loan can be converted into a fixed-rate loan, or an investment with a variable interest rate can be converted into one with a fixed interest rate. The receiver receives the fixed interest rate and pays the variable interest rate. The payer pays the fixed interest rate and receives the variable interest rate. The cash flows from the LIBOR payments depend on the relevant LIBOR fixing and are thus not yet known (except for the first fixing). The LIBOR fixing takes place every six months, two London banking days before the next interest-rate period. The LIBOR payments are due at the end of each six-month period. It is difficult to hedge non-period-linked products, such as the variable mortgage or the overdraft, because their interest-rate change does not correspond to a predefined model. It should also be borne in mind that the swap is only a hedging instrument; it is not used to procure liquidity. The minimum amount for an IRS is CHF 5,000,000. In addition to the classical interest-rate swaps, there are other swap transactions: Cross-Currency Interest-Rate Swap In contrast to the interest-rate swap, the cross-currency swap involves the exchanging of the interest rates of two different currencies. For example, one party pays the USD interest rate on a fixed basis for 7 years and receives the interest rate for 7 years in CHF on a fixed basis. The corresponding underlying capital amounts are exchanged at the start and end of the contract period. The basis for this transaction could be: ■ the financing of subsidiaries or projects in a foreign currency; ■ the hedging of interest-rate or currency risks; ■ the exploiting of different credit margins in different capital markets.
Forward-Start Swap If the idea is to profit from current market conditions, but the interest-rate risk only applies in a couple of months, it is possible for the present market rates to be “reserved” for the future swap by means of a forward-start swap. This is a liability. If the aim is to achieve this without a liability, the swaption is the right instrument. Swaption It is also possible to purchase an option on a swap transaction (Swaption = Swap Option). The purchaser is thus entitled but not required to conclude a swap on a specific date in the future at the predetermined conditions. Basically, a distinction is made between receiver swaptions (right to receive a fixed rate of interest) and payer swaptions (right to pay a fixed rate of interest).
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