At the time of the implementation of a swap contract, it is generally considered “currency,” which means that the total value of fixed-rate cash flows over the term of the swap is exactly the expected value of variable cash flows. In the following example, an investor has chosen to be fixed in a swap contract. If the front libor curve or the sliding interest rate curve is correct, the 2.5% it receives is initially better than the current floating LIBOR rate of 1%, but after a while its fixed 2.5% will be lower than the variable rate. At the beginning of the swap, the “net net worth” or the sum of expected profits and losses should be zero. At the end of 2007, Company A paid Company B 20,000,000 USD – 6% – 1,200,000 USD. As of December 31, 2006, the one-year LIBOR was 5.33%; As a result, Company B pays Company A 20,000,000 USD (5.33% – 1%) – USD 1,266,000. In a simple vanilla interest rate swap, the variable interest rate is generally determined at the beginning of the settlement period. As a general rule, swap contracts allow payments to be compensated against each other in order to avoid unnecessary payments. Here, Company B pays $66,000 and Company A nothing.
At no time does the captain change ownership, which is why he is referred to as a “fictitious” amount. Chart 1 shows cash flow between parties each year (in this example). Some companies have a comparative advantage in acquiring certain types of financing. However, this comparative advantage cannot apply to the type of funding desired. In this case, the company can acquire the financing for which it has a comparative advantage, and then use a swap to transform it into the type of financing it would like. The effective description of an interest rate swap (IRS) is an exchange agreement between two counterparties that indicates the nature of an interest rate exchange of payments. The most common IRS is a fixed swap in which one party will make payments to the other on the basis of a fixed interest rate initially agreed to obtain repayments on the basis of a variable interest rate index. Each of these payment series is called “leg,” so a typical IRS has both a fixed leg and a floating leg. The fluating index is usually an interbank rate (IBOR) with a specific tone in the corresponding IRS currency, z.B LIBOR in GBP, EURIBOR in EUR or STIBOR in SEK.