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onal versit nki An Example of an Interest Rate Swap XYZ Corp. has $200M of floating-rate debt at LIBOR l.e, every year it pays that year's current LIBOR. XYZ would prefer to have fixed-rate debt with 3 years to maturity Retire the floating-rate and issue fixed rate debt (Transaction cost? Feasible?) Enter a strip of FRAS (FRA rates for each year varies) Enter a swap, in which they receive a floating rate and pay the fixed rate 13 6302 An Example (cont' d) Pay LIBOR (floating) Lender Borrower (XYZ) Pay 6.954896 (fixed) Swap Counterparty Receive LIBOR (floating) . On net, XYZ pays 6.9548% XYZ net payment - LIBOR + LIBOR - 6.9548% = -6.9548% Floating Payment Swap Payment Questions to Ask Where does 6.9548% come from? How to determine this swap rate? As a counterparty to the swap, the market-maker receives fixed and pays floating. Thus, the market- maker is facing the risk of high floating rate. (The XYZ uses interest rate swap to transfer the risk to the swap counterparty.) The market-maker will hedge the floating rate payments by using, for example, forward rate agreements