5.

Interest Rate Risk

Seminar slides
Demonstration - FRA

On the 1st September, Dwindle purchase a 3v12 FRA with a

notional amount of $10m at a rate of 8.9%.
•Deal date is 1st September
•Settlement date is 1st December
•On the 1st December the USD LIBOR rate is 8.6%

What is the compensation payable on the FRA and to who?

Demonstration - FRA
Demonstration - FRA
Demonstration - FRA
Demonstration - FRA
Demonstration - FRA

Suppose we reach the 1st of November and Dwindle decides they

no longer require the FRA.
•1v10 FRA quotes are 8.80 – 9.10%
•1st November LIBOR is 8.70%
•Dwindle sells the 1v10 FRA to the bank in order to cancel

•Calculate the settlement amount on the 1st November

Demonstration - FRA
This is now the sell
8.9%
contract, so all we need
to do is establish the net
LIBOR payment amount and we
This is the originalwork out
contract, we the cost of
receive LIBOR notionally
Dwindle
unwinding
because it is a contract for the thisBank
position
8.8%
difference between the two so
they net out.

LIBOR
 Demonstration - FRA

If this is starting to get confusing, lets contextualise it…

Contract start!

r rowi ng
Bo
period
1st Sept 1st Nov 1st Dec 31st Aug

We changed our minds! And

decided to cancel
Demonstration - FRA Difference between the buy and
sell contracts, calculated under
the same calculation period
hence 274.

We wish to settle the contract on the 1st November

rather than the original date of 1st December, so we
discount back an extra month
Question 1 – Contract spec

Almost industries expects a $3,000,000 shortfall in 3 months

time, which is expected to last for 6 months. Which of the
following transactions would be most appropriate?

a)Buy a 3v6 FRA

b)Sell a 3v6 FRA
c)Buy a 3v9 FRA
d)Sell a 3v9 FRA
Question 1 - Answer

Almost industries expects a $3,000,000 shortfall in 3 months

time, which is expected to last for 6 months. Which of the
following transactions would be most appropriate?
FRA contracts are designed for
a)Buy a 3v6 FRA borrowers, so you buy if you want to
b)Sell a 3v6 FRA borrow and sell if you want to deposit.
c)Buy a 3v9 FRA Selling also allows to unwind or cancel
out a buy position as per the
d)Sell a 3v9 FRA
demonstration.
Question 2 – FRA compensation

The quoted contracted given to Almost industries is as follows;

Term: 3v9
Rate: 6.00%
Principal amount: $3,000,000

Calculate the FRA compensation amount on the settlement date

if the prevailing LIBOR rate is 7.50%.

Assume there are a standard of 30 days in a single month.

Question 2 - Answer
Question 3 – FRA alongside borrowing

After having calculated the compensation settlement, calculate

the cost of the overall loan taking into account the FRA. Bear in
mind that this company borrows at 1% over LIBOR as a result of
its credit rating.
Question 3 - Answer
Question 4 – Interest rate swaps

Haslam co. is currently paying out a fixed rate of 5% on its debt,

it has decided to enter into a swap to pay 6 month LIBOR against
a fixed rate of 4% for the remaining 3 years left on the loan.
What is the hedged cost of the loan with the swap contract?
Question 4 - Answer

LIBOR
Haslam Co. Bank

4%

5% +LIBOR
-4%
+5%

The net hedged cost is LIBOR+1%

Debt holders
Question 5 – IRS settlement

It has come towards a settlement date for the swap that Haslam
co. entered into. They are required to settle the payments
outlined in the previous question. Here are the following LIBOR
rates, calculate what the net payment will be under the swap
only, not taking into account the payments to the creditor, on the
01/01/2016 based on a notional amount of £5,000,000:
•01/01/2015 – 4%
•01/07/2015 – 4.3%
•01/01/2016 – 4.1%
Question 5 - Answer

This question introduces some of the more technical details

regarding swaps, so don’t worry if you could not answer the
question.

The length of the period is dictated by the LIBOR rate we

selected, which was 6 month LIBOR. So every 6 months, this
swap has to be settled.
Question 5 - Answer
MCQs

1. Your company would like to convert an existing floating rate

liability into a fixed rate liability, the swap involves receiving:

a) Floating payments, and is plain vanilla

b) Fixed payments, and is plain vanilla
c) Floating payments, and is a basis swap
d) Fixed payments, and is a basis swap
MCQs

1. Your company would like to convert an existing floating rate

liability into a fixed rate liability, the swap involves you
receiving:

a) Floating payments, and is plain vanilla

b) Fixed payments, and is plain vanilla
c) Floating payments, and is a basis swap
d) Fixed payments, and is a basis swap