Interest Rate
Swaps
Interest Rate Swaps
are the agreement between two parties to exchange payment obligation
denominated in same currency. Interest Rate Swaps are based on Comparative
Advantage Theory.
LIBOR = London
Inter-Bank Offered Rate
MIBOR = Mumbai
Inter-Bank Offered Rate
In Interest Rate
Swaps parties agrees to borrow the money against their desire and exchange with
each other to get the advantage of Interest deduction.
EC = Effective Cost
of Interest in aggregate
Calculation of
Effective Cost Payable by both parties and Saving to both parties due to swap
Calculation of
Interest Rate Payable by both parties
|
Calculation of
Saving Due to Interest Rate Swaps
|
||
Interest Payment
to Lender
|
XXX
|
EC Without
Interest Rate Swap
|
XXX
|
Interest Payment
to Party
|
XXX
|
EC With Swap
Interest Rate Sap
|
(XXX)
|
Receive Interest
Payment from Party
|
(XXX)
|
Intermediaries’
Share, if any
|
(XXX)
|
Effective
Interest Cost to Party due to Swap
|
XXX
|
Saving
available to distribute among Parties
|
XXX
|
Overnight Index
Swaps (OIS)
Overnight Index
Swaps is a type of swap in which one leg in MIBOR and another leg is fixed
rate. MIBOR in OIS is compounded daily whereas fixed leg is not. In this swap
one party receive fixed and pay floating, another party pay fix and receive
floating. In case there is a Holiday than previous MIBOR of day on which
holiday is assumed to previous day MIBOR without compounding.
Calculation of
Fixed Interest Payment
Interest Received
at floating rate
|
XXX
|
Add: - Any
Payment on net settlement if any due to floating rate
|
XXX
|
Less: - Any
Amount Received on net settlement if any due to floating rate
|
(XXX)
|
Expected
Interest Rate Payment at Fixed Rate
|
XXX
|
Fixed Interest
Rate = Expected Interest Payment at Fixed Rate X 100
Principal
Convert Rate on
Yearly Basis.
|
|
Cap, Floor and
Collar Option
Cap
Cap is an option
strategy that protects the borrower under a floating rate note from rise in
Interest Rates. Individual option for Cap is known as Caplets.
In this type of
option buyer of cap option agrees to pay fixed rate and receive floating by
paying cap premium (i.e. Call Option).
Floor
Floor is an option strategy
that protects the investor under a floating rate instrument from fall in
interest rate. Individual option for Floor is known as Floorlets.
In this type of
option buyer of floor agrees to pay floating and receive fixed by paying floor
premium (i.e. Put Option).
Collar
Collar is a
combination of a cap and a floor. In this strategy buy cap and sell floor. By
taking collar floating rate borrower can reduce premium cost.
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