Sunday, June 29, 2014

IRS motivations - a few tips

See also - Trac Consultancy course handout includes many practical applications of IRS.
see also -- There's a better summary and scenarios in the blog on IRS dealers

Company B (Borrower aka Issuer) wants to borrow. Traditional solution is a bond issue or unfortunately .... a bank loan (most expensive of all), either fixed or floating rate. A relatively new Alternative is an IRS.

Note bank loan is the most expensive alternative, so if possible you avoid it. Only small companies with no choice take bank loans.

Motivation 1 for company B - reduce cost of borrowing fixed

Motivation 2 for Company B - betting on Libor.
* If B bets on Libor to _rise, B would "buy" the Libor income stream of {12 semi-annual payments}, at a fixed swap rate (like 3.5%) agreed now, which is seen as a dirt cheap price. Next month, the swap rate may rise (to 3.52%) for the same income stream, so B is lucky to have bought it at 3.5%.
* If B bets on Libor to _drop, B would "sell" (paying) the Libor income stream.

Say Company C is paying a fixed 5% interest, but believes Libor will fall. C wants to pay floating. C can swap with company A so as to pay libor. C will end up paying floating interest to A and receive 5.2% from A to offset the original 5% cost.

Why would A want to do this? I guess A could be a bank.

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