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CH06HullOFOD5Ebw.ppt

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CH06HullOFOD5Ebw

SwapsChapter 6 Nature of Swaps A swap is an agreement to exchange cash flows at specified future times according to certain specified rules An Example of a 揚lain Vanilla?Interest Rate Swap An agreement by Microsoft to receive 6-month LIBOR pay a fixed rate of 5% per annum every 6 months for 3 years on a notional principal of $100 million Next slide illustrates cash flows Millions of Dollars LIBOR FLOATING FIXED Net Date Rate Cash Flow Cash Flow Cash Flow Mar.5, 2001 4.2% Sept. 5, 2001 4.8% +2.10 ?.50 ?.40 Mar.5, 2002 5.3% +2.40 ?.50 ?.10 Sept. 5, 2002 5.5% +2.65 ?.50 +0.15 Mar.5, 2003 5.6% +2.75 ?.50 +0.25 Sept. 5, 2003 5.9% +2.80 ?.50 +0.30 Mar.5, 2004 6.4% +2.95 ?.50 +0.45 Cash Flows to Microsoft(See Table 6.1, page 127) Typical Uses of anInterest Rate Swap Converting a liability from fixed rate to floating rate floating rate to fixed rate Converting an investment from fixed rate to floating rate floating rate to fixed rate Intel and Microsoft (MS) Transform a Liability(Figure 6.2, page 128) Intel MS LIBOR 5% LIBOR+0.1% 5.2% Financial Institution is Involved(Figure 6.4, page 129) F.I. LIBOR LIBOR LIBOR+0.1% 4.985% 5.015% 5.2% Intel MS Intel and Microsoft (MS) Transform an Asset(Figure 6.3, page 128) Intel MS LIBOR 5% LIBOR-0.25% 4.7% Financial Institution is Involved(See Figure 6.5, page 129) Intel F.I. MS LIBOR LIBOR 4.7% 5.015% 4.985% LIBOR-0.25% The Comparative Advantage Argument (Table 6.4, page 132) AAACorp wants to borrow floating BBBCorp wants to borrow fixed Fixed Floating AAACorp 10.00% 6-month LIBOR + 0.30% BBBCorp 11.20% 6-month LIBOR + 1.00% The Swap (Figure 6.6, page 132) AAA BBB LIBOR LIBOR+1% 9.95% 10% The Swap when a Financial Institution is Involved (Figure 6.7, page 133) AAA F.I. BBB 10% LIBOR LIBOR LIBOR+1% 9.93% 9.97% Criticism of the Comparative Advantage Argument The 10.0% and 11.2% rates avail