What's?

What is a SWAP for a loan?

Laura Oliva Financial risk management guide Leave a Comment

The interest rate swap – also called IRS – is a contract with a financial broker in order to hedge changes in interest rates.

Swap Loan

A swap allows the person who borrows a loan to transform floating-rate payments into fixed-rate payments and vice versa.

Premiums do not have to be paid in advance at the signing of the swap contract, as is the case with “options” (i.e. put or call) and in the case of “CAP”.

Interest Rate Swap

Example

If we have a 100,000 euro floating-rate loan with maturity of five years with variable interest calculated at 3 month EURIBOR plus a margin of 2%, and we enter into a swap with a third party, we know with certainty that we will pay a fixed rate for the duration of the loan.

Amount of funding: € 100,000

Financing rate: 3 month Euribor +2% margin

3 Month Euribor rate: 0.3%

Fixed rate swaps: 1.3%%

Let’s see what happens after 1 year.

If the 3 month Euribor rate rose to 1.5%, and if I have made the swap, I am in a favourable position, I pay less interest.

Let’s see how.

CashFlowSwap:en.001

The company receives the Euribor rate (€ 1,500 – 1.5%), pays interest rate swaps (-1,300 euro – 1.3%) and pays interest due to the loan agreement (Euribor +2% or EUR 3,500).

Without the swap contract, the company would suffer financing interest equal to: 3 Month Euribor (1.5%) + 2% = 3.5% or € 3,500.

After another one year Euribor fell to 0.8%, in this case if you have entered into swap contracts are in a disadvantaged position. In fact, you will pay more and 3,300 (net balance of payments), instead of 2,800 if you had kept the floating rate loan without entering into the swap.

After another one year Euribor fell to 0.8%, in this case if you have entered into swap contracts are in a disadvantaged position. In fact, you will pay more and 3,300 (net balance of payments), instead of 2,800 if you had kept the floating rate loan without entering into the swap.

 

In conclusion, the advantages of the swap are:

• Allows you to fix the costs of financing

• It ’s an widely used and inexpensive instrument comported to other derivatives

• Do not require for an initial outlay (commission) as in the case of “options”.

 

Disadvantage of the swap:

• Do not allow to benefit from the reduction in interest rates.

 

 

Subscribe to eKuota

eKuota helps companies to achieve their financial goals.
Subscribe now to eKuota
About the Author

Laura Oliva

Twitter

Co-founder of eKuota. Degree in Corporate Finance from the Universita’ Luigi Bocconi in Milan, she has more than a decade of experience in capital markets. She was Head of Debt Capital Markets within the Allianz Group, she worked at a number of international investment banks. She was Global Product Specialist, Head of Structured Finance and ABS team, Head of Syndication and Credit Analyst. She managed and executed bond issues and loans syndication for major italian companies. She is a Fixed income and Securitization expert, she deals with financial analysis and financial markets. Co-Author of the AdviseOnly blog. Mom of three, born in Rimini now she lives happily in Milan.

Related Posts

Leave a Reply

Your email address will not be published. Required fields are marked *