Interest rate swap is a term in commodity swaps. In today’s article, we will learn about interest rate swaps.

Type of interest rate:

LIBOR (London Interbank Offered Rate) London Interbank Offered Rate. The LIBOR interest rate provided by the bank refers to the interest rate charged by the bank when it provides corporate funds to other large banks, which means that this bank uniformly uses this interest rate to deposit funds in other large banks. Some large banks or other financial institutions offer 1-month, 3-month, 6-month and 1-year LIBOR interest rates for many major currencies.

LIBID (LondonInterbankBidRate) London Interbank Offered Rate. The bank agrees that other banks deposit funds into their own bank with LIBID. At any given moment, the quotation of LIBID and LIBOR given by the bank will have a small margin (LIBOR is slightly higher than LIBID).

The above two interest rates depend on bank transactions and are constantly changing to ensure the balance between the supply and demand of funds. The LIBOR and LIBID trading markets are called Eurocurrencymarket. This market is not controlled by any government.

Reporate In a repurchase contract (repoagreement), the investor holding the securities uniformly sells the securities to the other party of the contract and will buy back the securities at a slightly higher price in the future. The other party in the contract provided a capital loan to the investor. The price difference between selling and buying back securities is the loan interest rate, which is called the repurchase interest rate.

Zerorate, N-year zero-interest rate refers to the rate of return obtained after the funds invested today are maintained for N consecutive years. All interest and principal are paid to investors at the end of year N, and no interest income will be paid on the investment before the expiration of year N. The zero interest rate starting from N years is sometimes also referred to as the spot rate for N years, or the zero interest rate for N years, or the zero rate for N years.

Forward interest rate (Forward interest rate) is the interest rate for a certain period in the future implied by the current zero interest rate.

Why do the two companies want to conduct interest rate swap transactions? Don’t forget, AAA wants floating interest rates, and BBB wants fixed interest rates. But the markets where they have comparative advantages are just the opposite. Therefore, the two should conduct interest rate swap transactions.

Assume that the interest rates required for AAA and BBB in the market are as follows (the places in bold are the markets with comparative advantages):

Fixed interest rate market:

AAA: 4% BBB: 4%+1.2%=5.2%

Floating rate market:

AAA: LIBOR-0.1% BBB: LIBOR+0.6%

Therefore, the two can carry out such interest rate swaps to achieve their respective goals: AAA pays BBB LIBOR every period, and BBB pays AAA 4.35% every period. In this way, the LIBOR that BBB needs to pay on debt is canceled. In fact, the interest rate that BBB needs to pay is 0.6%+4.35%=4.95%, which is less than the 5.2% interest rate he needs to pay to borrow funds directly at a fixed interest rate. . In the same way, the interest rate that AAA actually needs to pay is LIBOR-4.35%+4%=LIBOR-0.35%, which is less than the interest rate that AAA needs to pay in the floating interest rate market. The sum of the interest rates saved by the two is 0.5%.

The advantages of interest rate swaps:

① Less risk. Because interest rate swaps do not involve principal, the two parties only swap interest rates, and the risk is limited to the part of interest payable, so the risk is relatively small

②Slightly influential. This is because interest rate swaps have no effect on the financial statements of both parties, and the current accounting rules do not require interest rate swaps to be listed in the notes to the statements, so they can be kept confidential.

③The cost is lower. Through the exchange, both parties have realized their wishes and reduced the cost of financing

④The procedures are relatively simple, and the transaction is completed quickly. The disadvantage of interest rate swaps is that the swap does not have standardized contracts like futures transactions, and sometimes the other party to the swap may not be found.