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Thread on swaps:

A swap is an agreement to exchange cash flows at certain specified future times according to certain specified rules.

example An agreement by X to pay fixed rate of interest of 5% per annum for 6 months for a 6 month libor for 2 years on a notional principal of 100 million dollars. Suppose today is 1st march2012 and 6 month libor rate is 4.5% and X enters into the swap agreement as cited above. Than cash flows exchange will began after 6 months for every 6 months for 2 years. Thus payments will be as:

1Sept2012: payment by X: 5%/2=2.5% receipt by X:4.5%/2=2.25% so X makes a net payment of 2.5%-2.25%=.25%. Libor today is 5%

1March2013: payment by X: 5%/2=2.5% receipt by X:5%/2=2.5% so X makes a net payment of 2.5%-2.5%=0%. Libor today is 5.5%

1Sept2013: payment by X: 5%/2=2.5% receipt by X:5.5%/2=2.75% so X makes a net payment of 2.5%-2.75%=-.25%. Libor today is 4%

1March2014: payment by X: 5%/2=2.5% receipt by X:4%/2=2% so X makes a net payment of 2.5%-2%=0.5%. Libor today is 5.5%

From above its clear that Libor rate today determines the payment 6 months afterwards. While the payment by X remains the same as 5% for 6 months on notional principal.

thanks

A swap is an agreement to exchange cash flows at certain specified future times according to certain specified rules.

example An agreement by X to pay fixed rate of interest of 5% per annum for 6 months for a 6 month libor for 2 years on a notional principal of 100 million dollars. Suppose today is 1st march2012 and 6 month libor rate is 4.5% and X enters into the swap agreement as cited above. Than cash flows exchange will began after 6 months for every 6 months for 2 years. Thus payments will be as:

1Sept2012: payment by X: 5%/2=2.5% receipt by X:4.5%/2=2.25% so X makes a net payment of 2.5%-2.25%=.25%. Libor today is 5%

1March2013: payment by X: 5%/2=2.5% receipt by X:5%/2=2.5% so X makes a net payment of 2.5%-2.5%=0%. Libor today is 5.5%

1Sept2013: payment by X: 5%/2=2.5% receipt by X:5.5%/2=2.75% so X makes a net payment of 2.5%-2.75%=-.25%. Libor today is 4%

1March2014: payment by X: 5%/2=2.5% receipt by X:4%/2=2% so X makes a net payment of 2.5%-2%=0.5%. Libor today is 5.5%

From above its clear that Libor rate today determines the payment 6 months afterwards. While the payment by X remains the same as 5% for 6 months on notional principal.

thanks

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