So for those asking about the 6.25%. Both parties look at which rate they can borrow at the cheapest. In this case A has an absolute advantage over B in terms of borrowing rates (A can borrow at 6% fixed vs 8% and LIBOR vs LIBOR + 3%). B however has a comparative advantage over A in floating rate and will therefore borrow from the bank at the rate of LIBOR +3%. Meanwhile A will borrow 6% fixed from the bank. The QSD is 1.5%, which if split evenly is 0.75%. We then subtract 0.75 from the rates from both of the banks quoted floating and fixed rates of the loans that they DIDN'T take out. So for A it is LIBOR +1- 0,75% (QSD) = LIBOR + 0.25% B is 8% - 0.75% = 7.25%
Now we need to consider for part A= 5% (loan they took out) + LIBOR (what they want) - X= 7.25, solving for X we get 5.25%. This means that they receive 5.25% from B and B gets LIBOR from A. NOW one important thing to remember we can increase or decrease this fixed payment arbitrarily, as this is a negotiation between two parties. That is to say if we increase the fixed payment A receives from B from 5.25%, to 6.25%, we also need to increase the floating payment B receives from A by the same amount, to equilibrate both sides, so they both gain 0.75% from this swap. So LIBOR increases to LIBOR + 1. If we then solve the same equation for A we get: 5% + (LIBOR +1% - 6.25%) = LIBOR + 0.25
thank you so much. very well explained. i came here totally having totally no clue what my notes is trying to explain but now i everything makes sense.
Observation - How is it win-win situation for both: A has managed to make fixed (6%) to floating at lower % (Libor + 0.5) instead of (Libor +1) that it would have paid outside market. So, 0.5 gain from floating market & 0.25 gain from B. B has managed to make floating (Libor + 1.5%) into fixed (6.25+1) 7.25% instead of 8% that it would have paid outside market. B is directly getting 0.75 gain on fixed now.
I don't fully understand your statements, but according to your own logic -- A makes a 0.75 gain (0.5 from float, 0.25 from B), while B makes a 0.75 gain from fixed. So, it's a win of 0.75 for both parties.
In this example, the fixed rate of 6.25% is negotiated between the two parties. They could have negotiated another rate, but this is what they both agreed upon.
Company B pays a premium of 2% on the fixed rate over company A, but only 0.5% premium at the floating rate. The difference in premiums is the comparative advantage. In other words, if A borrows at the fixed rate, the combined benefit to both companies would be +2%. However, if A borrows at the fixed rate, B must borrow at the floating rate to make the swap deal possible. When B borrows at the floating rate, there is a combined loss to the two of 0.5%. The net result is +2% - 0.5% = 1.5%.
for the diagram, I am a bit confusing. since the statement is A wants floating rate, and B wants fixed rate. that's why A pays floating rate to B and B pays fixed rate to A ? also for each company to pay its lender. since the absolute advantage for fixed is 2% which is >0.5% so A is better off with fixed rate compares to B, therefore A pays its lender with fixed rate and B pays its lenders with floating rate ? Am I right ?
Vanessa Tram But A doesn't want a fixed rate - they expect interest rates to fall so they think they'll be ultimately losing. And B doesn't want variable.
That could happen when the two companies have the same credit rating. For example, if both companies have AAA credit rating then comparative advantage may not exist. In that case, the company that is interested in an interest rate swap, would have to find another company that has a lower credit rating.
For general understanding if we say B pays 6.25% and LIBOR + 1.5% and A pays 6% and LIBOR + 0.75% (instead of LIBOR + 0.5%) that can justify 0.75% equal arbitrage sharing. Thus B totals 7 % and A totals LIBOR + 0.5%.
So is there any misslead in the video? I stuck in the moment where cashflow from B to A should be 7% not 6,25% cause they should share both cashlow equaly. Fixed rate is 2% different not 0,5% so there is a oppotunity to get lower Fixed rate for company B by 1%... 8-1 =7%. or why its 6,25?
Oh thanks so much. Really didn't know how to do it without the swap dealer involved. Can you sure us how find the net of receipts from a linear function with this same example?
You are perfectly right. You all the reason to be confused. the solution is not correct. This is my solution: In my calculation the Company A should pay LIBOR +0.25% and Company B should pay a fixed rate of 7.25%. Both parties are better of with 0.75%
Consider a 6 month OIS Notional Price = INR 200 Fixed Rate = 7.5% Floating Rate = NSE Overnight MIBOR Under the structure of the swap, the Fixed Rate is nominal rate, MIBOR is compounded daily (on holidays the previous MIBOR is taken) Consider 182 days in the period of SWAP, 365 days in a year MIBOR remains constant for the entire period at 6.90% What is the amt to be exchanged at the end? Answer is INR 0.479 (Can you show the calculation for it)
The part about LIBOR changing impacting the transaction is wrong. Neither company cares if LIBOR moves. Company A still is paying less than LIBOR+0.25 effectively, which is less than what it was quoted while Company B pays 7.25 effective which is less than what is quoted. There is a default risk, yes, and as LIBOR goes up, company A may be at higher default risk. But LIBOR moving won’t force company A to take a loss.
Great video - however doesnt make it easier for me to answer the following Question if you are able to assist: - Metro fund is a buyer of floating rate assets of 3 years maturity, with a minimum return of Libor +8bp -City corp has launched a 3 year bond which pays 9.25% semi annually and is currently trading at par -if 3 year swaps are quoted as 9.15%-9/20% -should metro fund buy the bond? much obliged if you are able to help answer this.
5:12 why company B loses 1% since they pay L+1,5% and collect L+0,5%. They gain(I should say they save) 0,5 % paing Netto Libor +1%, same as you explained that at Fixed rate company A pays 6% but recievs 6,25% so they pay Fixed 6 (-0,25%%) Netto they pay 5,75%...? am I right?
Co. A------------------ pay 6% ------------->A's lenders B's lenders Net: Co.B will need an extra 1% to pay B's lenders. Watching this video cause I am gonna have an exam for this topic and seeing ur comment. Hope that it could help u out.
Thanks for this wonderful explanation. I do really appreciate your effort. However, I think the solution you provided is not accurate. In my calculation the Company A should pay LIBOR +0.25% and Company B should pay a fixed rate of 7.25%. Both parties are better of with 0.75%
A bit confused... Comp A has the obligation to pay 6% ($60.000) fixed to its lender for the loan and LIBOR+0.5% ($55.000) to Comp B on Swap agreement? What's the deal here then? It goes far beyond the roof:) Am I missing smth here?)
He isnt going to use indian sentences midway right ? I got so annoyed by CFA/ACCA help videos where the guy teaching was on the verge of making soemthing clear then switches to indian, then english then indian..
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10s in and my understanding of swaps moved from 1% - 95% = THANK YOU!!
So for those asking about the 6.25%. Both parties look at which rate they can borrow at the cheapest. In this case A has an absolute advantage over B in terms of borrowing rates (A can borrow at 6% fixed vs 8% and LIBOR vs LIBOR + 3%). B however has a comparative advantage over A in floating rate and will therefore borrow from the bank at the rate of LIBOR +3%. Meanwhile A will borrow 6% fixed from the bank. The QSD is 1.5%, which if split evenly is 0.75%. We then subtract 0.75 from the rates from both of the banks quoted floating and fixed rates of the loans that they DIDN'T take out.
So for A it is LIBOR +1- 0,75% (QSD) = LIBOR + 0.25%
B is 8% - 0.75% = 7.25%
Now we need to consider for part A= 5% (loan they took out) + LIBOR (what they want) - X= 7.25, solving for X we get 5.25%. This means that they receive 5.25% from B and B gets LIBOR from A. NOW one important thing to remember we can increase or decrease this fixed payment arbitrarily, as this is a negotiation between two parties. That is to say if we increase the fixed payment A receives from B from 5.25%, to 6.25%, we also need to increase the floating payment B receives from A by the same amount, to equilibrate both sides, so they both gain 0.75% from this swap. So LIBOR increases to LIBOR + 1. If we then solve the same equation for A we get: 5% + (LIBOR +1% - 6.25%) = LIBOR + 0.25
thank you so much. very well explained. i came here totally having totally no clue what my notes is trying to explain but now i everything makes sense.
Brilliantly explained.....so much more simpler than my text
You my friend should get a peace prize.. awesome!! thank you !!
I am still very confused.
watch: th-cam.com/video/ZwQfGpHukvU/w-d-xo.html
Yes.
Observation - How is it win-win situation for both:
A has managed to make fixed (6%) to floating at lower % (Libor + 0.5) instead of (Libor +1) that it would have paid outside market. So, 0.5 gain from floating market & 0.25 gain from B.
B has managed to make floating (Libor + 1.5%) into fixed (6.25+1) 7.25% instead of 8% that it would have paid outside market. B is directly getting 0.75 gain on fixed now.
I don't fully understand your statements, but according to your own logic -- A makes a 0.75 gain (0.5 from float, 0.25 from B), while B makes a 0.75 gain from fixed. So, it's a win of 0.75 for both parties.
Thank you very much for explaining the topic is a simple and clear manner
In this example, the fixed rate of 6.25% is negotiated between the two parties. They could have negotiated another rate, but this is what they both agreed upon.
so 6.25 is assumption (could be as well any number?) or is there any story behind it that comes from this advantage? Thanks
Company B pays a premium of 2% on the fixed rate over company A, but only 0.5% premium at the floating rate. The difference in premiums is the comparative advantage.
In other words, if A borrows at the fixed rate, the combined benefit to both companies would be +2%. However, if A borrows at the fixed rate, B must borrow at the floating rate to make the swap deal possible. When B borrows at the floating rate, there is a combined loss to the two of 0.5%. The net result is +2% - 0.5% = 1.5%.
for the diagram, I am a bit confusing. since the statement is A wants floating rate, and B wants fixed rate. that's why A pays floating rate to B and B pays fixed rate to A ? also for each company to pay its lender. since the absolute advantage for fixed is 2% which is >0.5% so A is better off with fixed rate compares to B, therefore A pays its lender with fixed rate and B pays its lenders with floating rate ? Am I right ?
Vanessa Tram But A doesn't want a fixed rate - they expect interest rates to fall so they think they'll be ultimately losing. And B doesn't want variable.
wow. I went from not understanding how the f#$@ interest rate swaps works to "bingo!" thank you! You the best!
Thank you very much. It can help me a lot
thank you for your effort very helpful
That could happen when the two companies have the same credit rating. For example, if both companies have AAA credit rating then comparative advantage may not exist.
In that case, the company that is interested in an interest rate swap, would have to find another company that has a lower credit rating.
What is libro plus 1% I now know libro is but what is 1 % spread.
Thank you so much. That was so helpful.
This helped me a lot to understand Interest rates swaps. Thank your for this
For general understanding if we say B pays 6.25% and LIBOR + 1.5% and A pays 6% and LIBOR + 0.75% (instead of LIBOR + 0.5%) that can justify 0.75% equal arbitrage sharing. Thus B totals 7 % and A totals LIBOR + 0.5%.
Perfect answer!!! AS the swap rates are decided by some intermediary so this can be possible that both gets 0.75% reduction in interest rates.
So is there any misslead in the video? I stuck in the moment where cashflow from B to A should be 7% not 6,25% cause they should share both cashlow equaly. Fixed rate is 2% different not 0,5% so there is a oppotunity to get lower Fixed rate for company B by 1%... 8-1 =7%. or why its 6,25?
how to get the 6.25%
Thank you very very much for this clarification!
Oh thanks so much. Really didn't know how to do it without the swap dealer involved.
Can you sure us how find the net of receipts from a linear function with this same example?
Urgent. I still confuse about the 6.25% fixed rate and Libor + 0.5%. How do we get that ?
These rates are assumed to be given. Normally, a swap dealer will provide these rates to both parties.
collegefinance Thank you for the prompt reply.
i am also confusing ,,,
You are perfectly right. You all the reason to be confused. the solution is not correct. This is my solution: In my calculation the Company A should pay LIBOR +0.25% and Company B should pay a fixed rate of 7.25%. Both parties are better of with 0.75%
someone need make this clear.exam will coming soon T_T still confused
Consider a 6 month OIS
Notional Price = INR 200
Fixed Rate = 7.5%
Floating Rate = NSE Overnight MIBOR
Under the structure of the swap, the Fixed Rate is nominal rate,
MIBOR is compounded daily (on holidays the previous MIBOR is taken)
Consider 182 days in the period of SWAP, 365 days in a year
MIBOR remains constant for the entire period at 6.90%
What is the amt to be exchanged at the end?
Answer is INR 0.479 (Can you show the calculation for it)
Good video
Good 👍
Thanks for this , it is nice one.
L
great video ! thanks !
Good video, well explained, thank you :)
The part about LIBOR changing impacting the transaction is wrong. Neither company cares if LIBOR moves. Company A still is paying less than LIBOR+0.25 effectively, which is less than what it was quoted while Company B pays 7.25 effective which is less than what is quoted.
There is a default risk, yes, and as LIBOR goes up, company A may be at higher default risk. But LIBOR moving won’t force company A to take a loss.
I have a question if there is a swap bank then is bid-ask spread quoted against LIBOR?
Thank you !
Great video - however doesnt make it easier for me to answer the following Question
if you are able to assist:
- Metro fund is a buyer of floating rate assets of 3 years maturity, with a minimum return of Libor +8bp
-City corp has launched a 3 year bond which pays 9.25% semi annually and is currently trading at par
-if 3 year swaps are quoted as 9.15%-9/20%
-should metro fund buy the bond?
much obliged if you are able to help answer this.
5:12 why company B loses 1% since they pay L+1,5% and collect L+0,5%. They gain(I should say they save) 0,5 % paing Netto Libor +1%, same as you explained that at Fixed rate company A pays 6% but recievs 6,25% so they pay Fixed 6 (-0,25%%) Netto they pay 5,75%...? am I right?
Co. A------------------ pay 6% ------------->A's lenders
B's lenders
Net: Co.B will need an extra 1% to pay B's lenders.
Watching this video cause I am gonna have an exam for this topic and seeing ur comment.
Hope that it could help u out.
Thanks for a very well done introductory explanation.
Really thank you a lot!
云里雾里。我的youtube不能播放了，一级页面可以打开。
你肯定看不懂啦。我上课学的东西，叫利率互换协议
+LI Xiang (Daniel) 请问6.25%怎么来的
what is the risk premium that make company b has comparative advantage
how to calculate this 6.25% and LIBOR+0.5
Same doubt 😅
Thanks a lot
Can someone please explain how is that there is a comparitive advantage of 1.5% - shouldn't this be 2.5 % - Please explain
dkumar50 risk premium of : 2% from fixed rate - .5% from floating rate = 1.5% (from the viewpoint of Co. B)
Thanks for this wonderful explanation. I do really appreciate your effort. However, I think the solution you provided is not accurate. In my calculation the Company A should pay LIBOR +0.25% and Company B should pay a fixed rate of 7.25%. Both parties are better of with 0.75%
I am bit confused who u got Libor+0.5% and 6.25 % fixed... Kinldy help
thanks a lot
A bit confused... Comp A has the obligation to pay 6% ($60.000) fixed to its lender for the loan and LIBOR+0.5% ($55.000) to Comp B on Swap agreement? What's the deal here then?
It goes far beyond the roof:) Am I missing smth here?)
You have assumed libor as 5% whereas it may move upwards or might get lower and thus the answer might change accordingly.
May i ask wt happen if no one has comparative advantage which mean different between fixed and floating are 0
TheYuenccyuen No arbitrage possibility exists and hence no possibilty of swap agreement.
Great stuff. Thanks.
how can i get copy of this powerpoint
Confused yes
He isnt going to use indian sentences midway right ? I got so annoyed by CFA/ACCA help videos where the guy teaching was on the verge of making soemthing clear then switches to indian, then english then indian..