Interest rate Swap

Q1. Suppose company A is AAA rated company located in the US. The company has borrowed USD 1
million floating rate of LIBOR+2% loan to finance its capital expenditure investments. Now the
interest rates are showing great volatility for two different period i.e. 5%, and 4% , as a result
the company is paying variable interest rate every different periods.
On the other hand Company B, who has borrowed USD 1 million at a fixed rate of 8% .The
management of the company felt that the they are paying higher interest to the bank.
On Dec. 31, 2006, Company A and Company B enter into a five-year swap with the following
terms:
• Company A pays Company B an amount equal to 7% per annum on a notional principal
of $1 million.
• Company B pays Company A an amount equal to one-year LIBOR + 1% per annum on a
notional principal of $1 million.
• Illustrate how both the companies benefit as a result of Swap Agreement.

Q2. Suppose company A is located in the US. The company has borrowed USD 2 million floating rate
of LIBOR+2% loan to finance its capital expenditure investments. Now the interest rates are
showing great volatility for three different period i.e. 4%, 5% & 6%, as a result the company is
paying variable interest rate every different periods.
On the other hand Company B, who has borrowed USD 2 million at a fixed rate of 9% .The
management of the company felt that the they are paying higher interest to the bank.
On Dec. 31, 2006, Company A and Company B enter into a five-year swap with the following
terms:
• Company A pays Company B an amount equal to 8% per annum on a notional principal
of $2 million.
• Company B pays Company A an amount equal to one-year LIBOR + 1% per annum on a
notional principal of $2 million.
• Illustrate how both the companies benefit as a result of Swap Agreement.

Q3. Company A and Company B have been offered the following rates per annum on a 20-million-
dollar loan for 5 Years.

Company Fixed rate Floating rate

Design a swap that will allow a bank acting as on intermediary to earn 0.1% per annum
and it should be equally attractive for both the companies. Company A requires floating
rate and company B requires fixed rate
 Q4. Company A and Company B have been offered the following rates per annum on a 20-million-
dollar loan for 5 Years.

Company Fixed rate Floating rate

Design a swap that will allow a bank acting as on intermediary to earn 0.8% per annum
and it should be equally attractive for both the companies. Company A requires floating
rate and company B requires fixed rate

Currency Swap

Q1. Assume ABC Corporation is a US based Company and also has its subsidiary company in India.
ABC Corporation is planning to make an investment of INR 7 crore through its subsidiary
company. If the subsidiary company takes loan in India then it can borrow at an interest rate of
14%.If the ABC Corporation takes loan in US to finance activities, it can borrow at an interest
rate of 6%.

Similarly, XYZ is an Indian company and also has its subsidiary company in the US. The parent
company in India have planned to invest in the US which will cost a company USD 1 million. The
Indian subsidiary in the US can borrow loan at a rate of 8%. If the XYZ Company takes loan in
India, then it can borrow at 12% interest rate.
Let’s assume that $1=INR 70
Since the requirement of both the companies are similar and both the companies are looking at
avoiding foreign exchange risk. Both the company decides to enter in to a SWAP agreement.
Illustrate how by entering in to SWAP agreement, both the parties benefit from this kind of
transactions.(Assume the loan period is for 5 years in each case)

Q2. Assume XYZ Corporation is a UK based Company and also has its subsidiary company in India.
XYZ Corporation is planning to make an investment of INR 8 crore through its subsidiary
company. If the subsidiary company takes loan in India then it can borrow at an interest rate of
12%.If the XYZ Corporation takes loan in UK to finance activities, it can borrow at an interest rate
of 6%.

Similarly, ABC is an Indian company and also has its subsidiary company in the UK. The parent
company in India have planned to invest in the UK which will cost a company 1 million pound.
The Indian subsidiary in the UK can borrow loan at a rate of 8%. If the ABC Company takes loan
in India, then it can borrow at 10% interest rate.
Let’s assume that 1Pound=INR 80
 Since the requirement of both the companies are similar and both the companies are looking at
avoiding foreign exchange risk. Both the company decides to enter in to a SWAP agreement.
Illustrate how by entering in to SWAP agreement, both the parties benefit from this kind of
transactions. (Assume the loan period is for 5 years in each case)

Q3. An Indian company is currently paying a fixed rate of interest of 6% per annum on a US dollar
loan of $1 million with a tenor of three years. The interest payments are due on December 31st
of each year. The company entered into a swap contract in January 1,2008 with a US based
company. The deal requires an exchange of interest and principal. The US based company has
an outstanding loan of Rs 20 million, on which it is paying a fixed interest rate of 10% per
annum. The loan has a tenor of four years. The next interest payment is due on December 31.
The exchange rate at the end of year 1,2 and 3 is expected to be Rs. 40/$, Rs 39/$ and
Rs 37/$. Identity a) Trade date    b) The settlement dates    c) The cash flows for the Indian
company d) The benefit (if any) for the Indian company from the deal.

Q4. An Indian company is currently paying a fixed rate of interest of 7% per annum on a US dollar
loan of $1 million with a tenor of three years. The interest payments are due on December 31st
of each year. The company entered into a swap contract in January 1,2008 with a US based
company. The deal requires an exchange of interest and principal. The US based company has
an outstanding loan of Rs 20 million, on which it is paying a fixed interest rate of 11% per
annum. The loan has a tenor of four years. The next interest payment is due on December 31.
The exchange rate at the end of year 1,2 and 3 is expected to be Rs. 33/$, Rs 36/$ and
Rs 22/$. Identity a) Trade date    b) The settlement dates    c) The cash flows for the Indian
company d) The benefit (if any) for the Indian company from the deal.

Interest rate risk

Numerical problems to Illustrate the inverse relationship between Interest rate risk and bond prices

1. Corporation ABC issued a 3% coupon bond, while corporation XYZ floated a 9% coupon bond.
Both bonds have 15 years to maturity, makes semi-annual payments, and have an YTM of 6%
Using the above details, analyze the following situation
A) If interest rates suddenly rises by 2%, what is the percentage price change of these bonds?
B) What if rates suddenly fall by 2% instead?

2. Both ‘Bond Druk’ and ‘Bond Drook’ have 7 percent coupons, make semiannual payments, and
are priced at par value. Bond Druk has 3 years to maturity, whereas Bond Drook has 20 years to
maturity.
a) If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond
Druk and Bond Drook?
b) If rates were to suddenly fall by 2 percent instead, what would be the percentage change in the
price of Bond Druk and Bond Drook?