Swaps

Describe a plain vanilla fixed for floating swap and explain how it might be used.

A plain vanilla fixed for floating is the exchange of fixed interest payments for floating interest payments. A swap is used when a floating rate borrower wants to hedge their interest rate exposure by paying a fixed interest rate.

Insurance company, IHI, is part of a swap agreement with investment bank Lachlin Bank on a notional principal of $70 million. IHI has agreed to pay Lachlin Bank the six month BBSW rate and receives 9% pa, convertible half-yearly. If the swap has a residual life of 18 months, and the next interest payment is due in six months, calculate the value of the swap for Lachlin, given BBSW rates (compounding continuously) for the corresponding 6, 12 and 18 month maturities are 9.69% pa, 9.86% pa, 10.05% pa and the half year BBSW rate on the next payment is known to be 10.6% pa compounding half-yearly. Give your answer in millions of dollars to 2 decimal places. Value = $___ million

Vswap=Bfl - Bfix Bfix=ke-r1×t1 + ke-r2×t2 + ke-r3×t3 + Pe-r3×t3 =3.15e-0.0969×0.5 + 3.15e-0.0986×1 + 3.15e-0.1005×1.5 + 70e-0.1005×1.5 =$68.7688 m Bfl=Pe-r1t + k*e-r1t =70e-0.0969×0.5 + 3.71e-0.0969×0.5 =$70.2239 m Vswap=$70.22388359...m - $68.76883725... million =$1.46 million

It is currently September 2001. Exactly one year ago, your company entered a one year swap with quarterly settlement payments, the last net settlement payment was today. Your company was the floating rate payer in the swap. The swap was for a notional principal amount of $20,000,000 and the swap rate was set at 2.27% pa. Over the year of the swap, the following spot BBSW rates applied at the start of each quarter. September 2000 - Spot BBSW: 2.03% - 91 day December 2000- Spot BBSW: 2.51% - 90 day March 2001 - Spot BBSW: 2.04% - 92 days June 2001 - Spot BBSW: 1.63% - 92 days Calculate the net settlement payments that were paid or received by your company. Make sure that you express the net payments made by your company as negative and all of the net payments received by your company as positive. Give your answers in dollars to the nearest dollar. Hint: The formula for calculating the net settlement payment for a swap gives the payment to be made by the fixed rate payer. In this question your company is the floating rate payer. The floating rate payer makes/receives exactly the opposite payments to the fixed rate payer. a)Net settlement payment = $ b)Net settlement payment = $ c)Net settlement payment = $ d)Net settlement payment = $

a)Net settlement payment = $11,967 (payment made) b)Net settlement payment = $-11,836 (payment received) c)Net settlement payment = $11,595 (payment made) d)Net settlement payment = $32,263 (payment made) Payment by fixed rate payer = Notional Amount x (rswap - rBBSW) x d/365

You are a company that has borrowed money using a one year BAB facility. You want to hedge your interest rate risk and have decided to use a swap. What side of the swap would you be seeking to enter? 1. become the floating rate payer in the swap 2. become the fixed rate payer in the swap

become the fixed rate payer in the swap. *BAB is a floating rate loan.

Lachlin Bank is an investment bank that plays the role of intermediary for most swaps transactions occuring in the Asia-Pacific region. It currently holds a currency swap agreement with racing series managing company SLT Ltd. Under the terms of the swap, Lachlin Bank is swapping its New Zealand Dollar (NZD) debt for SLT's Australian Dollar (AUD) debt. SLT and Lachlin have both, independently, determined that the swap is worth nothing to either of them. SLT's finance team recently reported it expects to receive $NZD13,800,000, while Lachlin expects to receive $AUD19,600,000. How many NZD does one AUD currently purchase? Give your answer in dollars to 2 decimal places. 1 AUD buys $NZ: ____

As Vswap = 0: S0 = BD/BF = 19,600,000 / 13,800,000 = 1.4203 number of NZ$ that 1 AU$ will purchase: 1/1.4203 = 0.70

Fantra, a global soft-drink manufacturer has recently entered into a swap agreement with intermediary Lachlin Bank. Under this swap agreement Fantra agreed to make floating rate payments to Lachlin Bank, while Lachlin Bank would make fixed rate payments to Fantra. Lachlin Bank then closed their exposure by entering a matching swap with another soft-drink manufacturer, Cloak. If in 6 months time the interest rates are such that the cash flow on the floating rate payments are less than the cash flows on the fixed rate payments, the value of the swap for Fantra will have increased or decreased or remained the same. The value of the swap Cloak entered with Lachlin bank, from Cloak's point of view, will have increased or decreased or remained the same.

- increased - decreased

How is the swap rate calculated in a swap? 1. It is the rate that makes the present value of the fixed rate obligations equal the present value of the floating rate obligations. 2. It is the forward rate implied by the yield curve at the start of the swap. 3. It is the average of all of the forward rates that are expected to apply throughout the swap. 4. It is reset regularly throughout the swap based on the yields in the BAB market.

1. It is the rate that makes the present value of the fixed rate obligations equal the present value of the floating rate obligations. *The swap rate is the fixed rate of a swap. It is calculated as the rate that makes the present value of the fixed rate obligations equal the present value of the floating rate obligations. This rate will be close to an average of the implied forward rates at the start of the swap but also allows for the time value of money.

Select the best description of a plain vanilla fixed for floating swap: 1. The borrowers make an agreement to exchange only each others interest payments. The agreement ensures that each borrower retains the responsibility for repaying the principal of their loan. 2. The borrowers make an agreement under which they exchange a set of fixed cash flows for floating cash flows that are separate from their loans. Both borrowers retain responsibility for their own loan interest and principal repayments. 3. The borrowers make an agreement to exchange their entire loans and take over each other's debt responsibilities.

2. The borrowers make an agreement under which they exchange a set of fixed cash flows for floating cash flows that are separate from their loans. Both borrowers retain responsibility for their own loan interest and principal repayments. *A swap means that two borrowers agree to exchange a notional set of interest repayments. This means that each borrower retains responsibility for their own loan. The actual interest and principal repayments made by each borrower on their underlying physical loan do not change. Instead, the two borrowers agree to a new security that operates in addition to, and does not alter, their existing loans. The new security is the swap. The two borrowers agree a pretend amount of a loan (usually between $10m and $50m) and agree a fixed and floating interest rate that will be paid on this notional amount of money. The borrower that has the underlying physical floating rate loan agrees to pay the fixed interest rate on the notional loan. However, each borrower retains responsibility for their own loan. The borrower that has the underlying physical fixed rate loan agrees to pay the floating interest rate on the notional loan. Both borrowers then pay each other the cash flows arising on this notional loan as well as paying the cash flows to their real investors on the underlying physical loans.

From the list below, select the two borrowers that are the most natural fixed for floating swap partners. 1. a borrower issuing bonds and a borrower issuing semis 2. a government borrower using semis and a BAB facility borrower 3. a BAB facility borrower and a borrower who raises money with promissory notes

2. a government borrower using semis and a BAB facility borrower *A fixed for floating swap is an exchange of fixed interest payments for floating interest payments. It is usually arranged between a fixed rate borrower and a floating rate borrower who both want to exchange their interest rate exposures. In the above examples, the BAB facility is a floating rate loan while a semi (which is like a bond) is a fixed rate loan. Accordingly these two borrowers would make the most natural swap partners. In the above examples, note that BABs and promissory notes are both floating rate loans so these two borrowers both have the same interest rate exposure (so cannot swap with each other). Similarly, bonds and semis are both fixed rate loans, so these two borrowers cannot swap their respective exposures.

Select all the statements that are true regarding currency swaps: 1. The value of a currency swap is equal to the difference between the expected present value of payments on the domestic currency and the expected present value of payments on the foreign currency. 2. Currency swaps are priced using only exchange rates where interest rate swaps are priced using only interest rates. 3. The principal amount is swapped at the expiration of the swap contract. 4. Currency swaps are not profitable when there are differences between the domestic and foreign interest rates. 5. Currency swaps are unlike interest rate swaps because principal amounts are traded in the course of the swap contract.

3, 5 *The main difference between a currency swap and a interest rate swap lies in the fact that, firstly, exchange rates and foreign rates of interest are used in currency swaps whereas an interest rate swap only deals with domestic interest rates. While an interest rate swap involves transforming a fixed-rate to a floating rate and vice versa, a currency swap involves transforming a domestic rate into a foreign rate and vice versa. Secondly, there is an exchange of principal at the commencement and expiration of the swap. The principals that are exchanged between the parties are equal in value but different in currency type (for example, Australian dollar, Euro, British pound). Currency swaps are profitable to swap parties when the difference between the domestic and foreign interest rates creates a comparative advantage situation. For example, if the cost of borrowing Australian dollars is higher by 1% for Company A than Company B, and the cost of borrowing US dollars is also higher by 1% for Company A, then there is no comparative advantage of Company B over Company A and thus there is no net difference between the interest rates. When there is no comparative advantage, no profit may be made via a currency swap. The value of a currency swap is equal to the difference between the expected present value of payments on the domestic currency and the expected present value of payments in the foreign currency multiplied by the exchange rate (in order to convert the value in foreign currency to the value in domestic currency). The periodic payment on currency swaps is calculated by looking at the interest rates, converted into the domestic currency by multiplying by the appropriate exchange rate.

A swap is said to be similar to a strip of FRAs. This is true, but there is one major difference between a swap and a strip of FRAs. What is that major difference? 1. A swap can be entered today, but a FRA strip must be deferred. 2. A swap can lock in a single fixed rate for the entire period, while a FRA strip locks in rates that are different each period. 3. A swap can lock in a single fixed rate for the entire period, while the rates under a FRA strip vary each period. 4. A FRA strip can be entered today, but a swap must be deferred.

A swap can lock in a single fixed rate for the entire period, while a FRA strip locks in rates that are different each period.

A swap is an exchange of two sets of cash flows that have the same expected ___ value at the start of the swap.

Present or discounted *A swap is used when a borrower that has fixed rate funds wants to pay a floating interest rate (or vice versa). A swap means that two borrowers agree to exchange a notional set of interest repayments. The borrower that has the fixed rate loan agrees to pay a floating interest rate and the borrower that has the floating rate loan agrees to pay the fixed interest rate. However, each borrower retains responsibility for their own loan. A swap does not cost any money to enter into. The reason that a swap is free is that at the start of the swap the two borrowers expect that the amounts of money that they will both pay will be identical. This means that the fixed interest repayments have the same present value as the floating interest payments.

The Australian branch of soft-drink manufacturer Fantra currently has an outstanding liability of $USD7,000,000 which it is paying off at 7% pa with interest payable annually. a) The risks Fantra is exposed to here include (select all those that apply): - exchange rate risk - interest rate risk - credit risk - settlement risk b) If Fantra were to swap this liability for an equivalent AUD liability, an appreciation of the Australian dollar would increase or not affect or reduce the value of the swap. c) Supposing Fantra enters into a swap with DCB Bank when one Australian dollar was worth $USD0.7, calculate the intial cashflow from DCB Bank to Fantra. Give your answer in terms of the dollar the cash flow will occur for. For example if DCB are to pay Fantra in USD, give the USD value of the cashflow, or vice versa. Give your answer in dollars to the nearest dollar. Initial cash flow: ___

a) exchange rate risk b) reduce c) A$10,000,000 * (a) The two major risks tend to be credit risk and settlement risk. Credit risk is the risk of a borrower defaulting on interest and principal payments. The intermediary will still have to honour the matching swap agreement with the other (offsetting) counterparty, and loses the hedge it had against interest/exchange rate movements, and then becomes exposed. As long as both parties continue to make payments, the intermediary is fully hedged against movements, but once one party defaults, the intermediary loses that hedge and becomes fully exposed. Settlement risk is the risk that, due to timing differences, one party will not settle while the other party has settled. Suppose the intermediary pays Fantra the interest payment due on a given date, but Fantra does not make the appropriate payment to the intermediary immediately. Until Fantra makes the payment, the intermediary is again fully exposed to exchange rate movements. These timing differences pose a significant risk, and appear again through a mismatch on either the timing of the payments, or the sizes of the debt, or the maturities. For example, it may happen that the intermediary takes some time before it is able to find a party to enter an offsetting swap agreement with, and during this time the intermediary will remain exposed. These risks are very much an issue in currency swaps due to time zone differentials often creating mismatches in offsetting transactions. Intermediaries must implement appropriate strategies to minimise (if not eliminate) these risks, especially on the exchange of principal amounts which are typically for very large sums. In the case of Fantra, however, since the interest rate is fixed at 7% pa, no risk is present from changes in floating interest rates, since this is effectively a locked in rate of interest. Since Fantra is making the repayments and has already obtained the loan, credit risk is not an issue for Fantra, although it is very much a risk present for the party it owes. b) Vswap=S0BF - BD The appreciation of the AUD will result in one USD purchasing fewer AUD, thus reducing the value of S0, so the value of S0BF will decrease and since the value of the swap is positively related to this, the value of the swap will decrease. c) C = P/So = 7,000,000 / US$0.7 = A$10,000,000

Select the statement that is not true of currency swaps: - The principal amount is swapped at the expiration of the swap contract. - A currency swap involves transforming a domestic rate into a foreign rate or a foreign rate into a domestic rate. - Currency swaps are unlike interest rate swaps because principal amounts are traded in the course of the swap contract. - The value of a currency swap is equal to the difference between the expected present value of payments on the domestic currency and the expected present value of payments on the foreign currency.

The value of a currency swap is equal to the difference between the expected present value of payments on the domestic currency and the expected present value of payments on the foreign currency. *The value of a currency swap is equal to the difference between the expected present value of payments on the domestic currency and the expected present value of payments in the foreign currency multiplied by the exchange rate (in order to convert the value in foreign currency to the value in domestic currency). The periodic payment on currency swaps is calculated by looking at the interest rates, converted into the domestic currency by multiplying by the appropriate exchange rate.

Lachlin Bank has a fixed-rate liability that incurs a coupon rate of 4.1% pa payable annually. Lachlin Bank feels that the Bank Bill Swap Rate (BBSW) will fall below this fixed rate in the future and wishes to transform this liability from being fixed-rate to floating rate. Therefore, Lachlin Bank entered a swap arrangement with DCB Bank on a notional principal of $20,000 whereby Lachlin Bank pay DCB Bank BBSW + 40 basis points per annum each year in return for a fixed-rate payment of 4.1% pa. During the first year, the BBSW rate was 4.6% pa. a)Calculate the cash outflow that Lachlin Bank will need to pay DCB Bank in the first year. Give your answer in dollars and cents to the nearest cent. Cash outflow = $ b)Lachlin Bank made a profit or loss from the swap after the first year.

a) $1,000 b) loss *Lachlin Bank will need to pay DCB Bank coupons on a notional principal of $20,000 at the coupon rate of BBSW + 40 basis points. Each basis point is equivalent to 0.01%. The cash outflow payment can be calculated using the following formula Coutflow=cash outflow = unknown routflow=outflow rate = 0.046 + 0.004 = 0.05 P=notional principal = $20,000 Coutflow=routflow × P =0.05 × 20,000 =1,000 (b) The net cash flow after the first year can be calculated after subtracting the cash inflows with the cash outflows. The cash inflow is equal to the rate the Lachlin Bank is receiving from DCB Bank multiplied by the notional principal and can be calculated using the following formula: Cinflow=cash inflow = unknown Cnet=net cash flow = unknownr inflow=inflow rate = 0.041 P=notional principal = $20,000 Cinflow=rinflow × P =0.041 × 20,000 =820 Therefore, the net cash flow created by the swap is: Cnet=Cinflow −Coutflow =820 − 1,000 = -180 Since the net cash flow is negative, Lachlin Bank has made a loss from the swap.

StandPoor Bank is a small bank that has had a torrid past riddled with excessive debts and multiple near bankruptcies. As a result most institutions are cautious in their lendings to StandPoor, particularly on floating rate debt because they believe StandPoor cannot be trusted to sustain its operations when exposed to interest rate changes. StandPoor Bank is able to lock in fixed rates at 21% pa but can only lock in floating rates at (BBSW+20)% pa. SitWell Bank, however, is a trusted and prosperous firm, whose reputation has only been bolstered by the recent addition of succesful housing development 'Sudden Valley' to its portfolio. SitWell is able to secure fixed rate funds at 6% pa and floating rate funds are (BBSW+1)% pa. a)If SitWell and StandPoor enter a swap agreement to split the interest savings equally, and StandPoor pays Sitwell interest at (BBSW+20)% pa, what fixed rate does SitWell agree to pay StandPoor? Give your answer as a percentage per annum to the nearest whole percent. Fixed rate = __% pa b)If SitWell and StandPoor were to enter this agreement using an intermediary such an investment bank, the saving they could achieve would be greater than or smaller than or the same as before.

a) 23% b) smaller than * (a) difference in fixed-rate: 15% difference in floating-rate: BBSW+19% Net differential = 4% Spilt into the 2 companies: 2% This saving can occur when either firm uses its comparative advantage in the physical market, which is fixed rate funds for StandPoor and floating rate funds for SitWell. Therefore, by entering the swap agreement StandPoor should effectively obtain floating rate funds for (BBSW+18)% -> (BBSW+20%-2%) and SitWell should obtain fixed rate funds at 4% pa -> (6%-2%). We know StandPoor is paying SitWell floating rate interest at (BBSW+20)% pa. So its effective rate of interest: BBSW+18% = BBSW+20% + 21% - X, where X is the fixed rate it receives from SitWell in exchange for its floating rate payments and the 21%. Re-arranging this formula we get: X = BBSW+20% + 21% -(BBSW+18%) = 23% pa As a check, we can calculate the effective fixed rate of interest SitWell will be paying under this arrangement: Effective fixed rate for SitWell = BBSW+1% + 23% - (BBSW+20%) = 4% pa So we can see that this swap provides both firms with the maximum saving of 2% pa each (4% pa in total) when SitWell agrees to pay StandPoor 23% pa.

Macrohard is a large blue chip company which currently has a fixed-rate liability that pays coupons at a rate of 10% pa. Eboda is a smaller company that has a floating rate liability that pays the annual Bank Bill Swap Rate (BBSW) + 10 basis points. The two companies are currently in a swap arrangement whereby Macrohard pays Eboda a floating rate of BBSW in return for a fixed rate of 9.5% pa. a)The effective rate that Macrohard needs to pay is: - BBSW - BBSW + 50 basis points - 10% pa - 50 basis points b)The effective rate that Eboda needs to pay is: - 9.5% pa - BBSW + 10 basis points - 10 basis points - 9.6% pa

a) BBSW + 50 basis points b) 9.6% pa * (a) This rate is calculated by subtracting all the outflow rates by the inflow rate eventuating from the swap. Macrohard needs to pay an interest rate of 10% pa due to its liability, and BBSW to Eboda. It receives a rate of 9.5% pa from Eboda from the terms of the swap. Therefore, the effective rate that Macrohard needs to pay is equal to 10% + BBSW - 9.5% = BBSW + 0.5%. Since 0.5% is the same as 50 basis points, Macrohard's effective rate is BBSW + 50 basis points. (b) Similarly, Eboda needs to pay an interest rate of BBSW + 10 basis points due to its liability, and 9.5% to Macrohard. It receives a rate of BBSW from Macrohard from the terms of the swap. Therefore, the effective rate that Eboda needs to pay is equal to (BBSW + 10 basis points) + 9.5% - BBSW = 9.6% pa.

Indicate whether the following statements about swaps are true or false. a)A swap is a security used to raise finance. True orFalse b)The description of a swap as plain vanilla means that it is used to exchange the vanilla bean for a different commodity. True or False

a) False b) False (a) A swap is a risk management security. A swap does not raise finance. It is normally used to change the interest rate that a borrower must pay on funds from a fixed rate to a floating rate (or vice versa).

Macrohard is a large software corporation that can obtain a 7.30% pa fixed rate of interest. Outtel is a government owned microchip manufacturing company. Outtel has a capital structure that is currently far less reliant upon debt than that of Macrohard, and subsequently can obtain a lower fixed interset of 5.40% pa. a)If Macrohard can obtain a floating rate loan at BBSW+2.50%, while Outtel can obtain a floating rate of BBSW+1.50%, Macrohard has a comparative advantage over Outtel in: fixed rates or floating rates or neither rate. b)If interest savings are shared equally, how much can Macrohard save on interest payments per annum by entering a swap agreement with Outtel? Give your answer as a percentage per annum to two decimal places. Saving = ____% pa

a) floating rate b) 0.45% p.a. *(a) fixed-rate differential: 7.30% - 5.40% = 1.9% floating-rate differential: BBSW+2.50 - BBSW+1.50 = 1% As the differential for floating rate is lower, Macrohard has a comperative advantage on floating rate. (b) (1.9 - 1)/2 = 0.45% The total saving available is the value of the net differential between fixed and floating rates. By entering a swap agreement, the combined saving for the two parties will be this net differential of 0.90% pa. If the savings are divided equally between the counterparties, the saving to either party will be half the combined saving, or net differential. Therefore, the saving Macrohard can achieve is 0.45% pa.

Answer the following questions about what happens when BBSW interest rates increase unexpectedly during the term of a swap. a)Who will now make larger than expected swap payments? fixed rate payer or floating rate payer or payments remain as expected b)You are a hedger with a swap and an underlying physical exposure. What has happened to your total position? made a loss or made a profit or no change

a) floating rate payer b) no change *(a) When the BBSW rate increases by more than expected, then the floating rate payer in the swap must now make larger swap payments than expected. (b) If the floating rate payer is a hedger, then they are using swaps to offset an underlying physical position. The floating rate payer in a swap is likely to have a fixed rate underlying position that they are hedging. If the BBSW rate just increased, then their physical position is now better off. This offsets their swap position that is worse off, so their total position does not change. In general, a hedger is someone who is seeking to eliminate risk by using derivative securities (such as a swap). This means that they enter a derivative position such that any change (good or bad) in their derivative position will be offset by an equal (but opposite) change in their physical position. In this way, the total position of a hedger remains unchanged.

Select whether the following statements regarding swaps and their terminology are correct or incorrect: a)Once a swap has been entered into, the loan is no longer the responsibility of the party who originally took it out before swapping. b)The party that borrows at a fixed rate in the physical market and then enters into a swap agreement to pay floating rates will leave itself vulnerable to changes in the relevant reference rate. c)700 basis points are equivalent to 7%. d)Where a company has a comparative advantage of 1% on floating rates, it will effectively pay 0.5% pa less on its fixed rate if it enters a swap agreement where savings are shared equally.

a) incorrect b) correct c) correct d) correct

Answer the following questions about the interest rates and payments made under an interest rate swap: a)On what basis are swap payments made? gross or net b)Which rate is known as the swap rate? fixed rate or floating rate c)If rswap is the lowest rate, who makes the payment? fixed rate payer or floating rate payer

a. net b. fixed rate c. floating rate payer *(a) - Swap payments are made on a net basis. This means that the amount owed by the fixed rate payer is calculated and then the amount owed by the floating rate payer is calculated and subtracted from this first amount. Only the left over amount is paid. (b) Swaps involve two interest rates, the fixed rate and the floating rate. The fixed rate is called the swap rate. The floating rate is known as the Bank Bill Swap Rate (BBSW). (c) If the swap rate is the lowest rate, this means that the fixed rate is lower than the floating rate. When the net payment calculation is done, the amount owed by the fixed rate payer will be less than the amount owed by the floating rate payer. As a result, the net payment amount will be negative. When the net payment amount is negative it is paid by the floating rate payer to the fixed rate payer.

Lachlin Bank has a liability where interest is payable half-yearly at 8% pa, and DCB Bank has a liability where interest is payable half-yearly at BBSW + 15 basis points. These two banks enter a swap whereby Lachlin Bank pays DCB Bank at a rate of BBSW in return for a rate of 7.5% pa. The interest rate risk exposure of the parties if there is an increase in the BBSW is that: a) neither parties are exposed and the risk is hedged b) Lachlin Bank is exposed c) both parties are exposed d) DCB Bank is exposed

b) Lachlin Bank is exposed *The effective rate in a swap is calculated by subtracting all the outflow rates from the inflow rates eventuating from the swap. Lachlin Bank pays an interest rate of 8% pa to its liability as well as the BBSW to DCB Bank. It receives a rate of 7.5% pa from DCB Bank from the terms of the swap. Therefore, the effective rate that Lachlin Bank needs to pay is equal to 8% + BBSW - 7.5%, which is equal to (BBSW + 0.5)% pa. Lachlin Bank will need to pay more if the BBSW rises, and therefore they are exposed to the risk of the BBSW rising. DCB Bank on the other hand needs to pay an interest rate of (BBSW + 0.15%) pa due to its liability, and 7.5% pa to Lachlin Bank. It receives a rate of BBSW from DCB Bank from the terms of the swap. Therefore, the effective rate that DCB Bank needs to pay is equal to BBSW + 0.15% + 7.5% - BBSW, which is equal to 7.85% pa. DCB Bank will be unaffected if the BBSW rises since any increase in their BBSW liability is offset by an increase in the amount they receive from Lachlin Bank. Therefore, the only company exposed to the risk is Lachlin Bank.

How is the BBSW calculated in a swap? a. It is the average of all of the forward rates that are expected to apply throughout the swap. b. It is the rate that makes the present value of the fixed rate obligations equal the present value of the floating rate obligations. c. It is reset regularly throughout the swap based on the yields in the BAB market. d. It is the forward rate implied by the yield curve at the start of the swap.

c. It is reset regularly throughout the swap based on the yields in the BAB market. *The BBSW rate is the floating rate of a swap. It is calculated using the spot rates in the 90 day BAB money market.

Select all the main swap counter parties from the list below: 1. financial institutions 2. small to medium companies 3. brokers 4. governments

financial institutions - hedge their interest rate exposures to balance their fixed and floating rate income and outgo. governments - large, powerful and very low risk borrowers. As a result they can attract very competitive fixed rate loans. Most large companies are unable to attract fixed rate loans and must pay floating rate funds. The government can exploit its relative advantage as a fixed rate borrower by borrowing fixed rate funds and swapping these with a large company that could not otherwise raise fixed rate finance.