Quiz 21: Interest Rate and Foreign Currency Swaps


A company wants to swap its fixed interest rate to debt into a floating interest rate debt. Following are the synopsis of the information related to swap: img Swap fixed interest to floating interest rate. img From the given information it is clear that the company will pay semi-annual LIBOR interest rate and it will receive fixed interest rate as a result of swap agreement. In this case, the currency involved is only dollar and there is just an adjustment in the interest amount to be paid and received. Since the transaction is on semi-annual basis, so use 0.5 (i.e. 6/12). img Following table discloses the amount to be received and paid in 3 year time period by company: img

The interest rate swap is nothing but an agreement between the counterparties which will enable the multinational corporation for changing the debt nature from a floating interest rate to fixed interest rate or fixed interest rate to floating interest rate. In this case, one counterparty will make payment on fixed interest rate on the notional principal amount to other counterparty of the agreement in turn will make payment in floating interest rate for the same amount of principal. The term notional principle implies the amount of basic principal based on which the cash flows towards the interest payment is dependent upon. In case of currency swap, there is no requirement for the exchange of principal as the principal amount will be equivalent in other currency. Generally, the net interest payment is only being made which dependents upon the fixed and floating interest rate, the counterparty which bears higher interest rate will be required to pay the net amount to the other.

The US Company which has significant asset in euro is planning to enter into a currency swap. Current exchange rate along with the interest rate in USD and in euro is provided in order to establish an appropriate swap. Following are the required information: img img From the given information it is clear, that the swap is possible. First the amount in US dollar has to be converted into euro using the current spot rate. img img The swap begins when the amount in US dollar converted into euro using the financial intermediary and receives the amount €7,407,407. If in case the interest rate is on semi-annual basis then the amount received by the company has to be determined. According to the transaction, the company will receive interest for the dollar amount and should pay interest in euro amount. Since the transaction is on semi-annual basis, use 0.5 (i.e. 6/12) in multiple of interest rate to get half yearly interest amount. img img Thus, every 6 months the company will receive $550,000 as interest and will pay €333,333 as interest. After the 8 th year, the actual principal amount will be exchanged. In other words, after 8 th year the company will receive $10,000,000 from the intermediary and has to pay €7,407,407 to the intermediary.