Due to an urgent working capital need, a company gets a 3-month bank loan at an annual rate of 22%. They expect a decline in interest rates and thus, they do not want to borrow at this high rate. Explain how they can use Overnight Index Swap (OIS) contracts to reduce their interest cost. The current fixed rate of the OIS contract is 19% with quarterly settlement.

Calculate the net interest cost if, as of 3 months from now:

a. The compounded (in-arrears) average of overnight OIS rates over the 3-month period turns out to be 18% per annum (that is, the OIS Index goes up from 100 to 104.2) expected good news

b. The average turns to be 20% per annum unexpected bad news