Swap - Lock in LIBOR

receiving, background, understand

Hey guys,

Could someone with a solid background and understanding of fixed income (specifically swaps) explain to me how through a swap you can lock in a 3 - month LIBOR?

I have read the CFAI text but I would like a more intuitive explanation.

I don't understand (p.235, Reading 55) how the party who pays a floating rate locks in a borrowing rate (if it pays floating how can he lock in???) and how the party receiving a floating payment locks in an amount to be received (since he receives floating payment!!)

Thank you in advance!

hassan

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2^#

发表于 2011-7-11 19:13 | 只看该作者

party paying floating rate - receives the fixed rate.
fixed rate was originally set up based on the LIBOR rates in effect at the time the swap originated.

If both payments are in the same currency - the payments would be netted and whoever (fixed payer or floating rate payer) owes more - pays the other.

Floating rate payer is receiving the fixed payment (without netting in effect). He swapped and received the fixed payment. So he locked in the fixed rate.
Fixed rate payer is receiving the floating payment (without netting). he swapped, received the floating payment. the lockin happens because the fixed rate at origination was based on the floating rates in effect at that time.... (you will see this in the Swaps chapter in derivatives).

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BelalM

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3^#

发表于 2011-7-11 19:13 | 只看该作者

he is locking in something because he is receiving a fixed rate in return. So that way he is getting the "FIXED" rate - while he pays the Floating rate. By swapping those flows - he is less uncertain about what amount he will get.

Fixed Rate Payer - pays fixed, receives floating.
He will agree to this if he is convinced that the Floating rates in future will GO UP.
In that way - (with netting in effect) - he will receive a sum of money.
Compare this to a Fixed Income Bond where you are the issuer (and you are paying a fixed coupon each period).

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Kapie

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4^#

发表于 2011-7-11 19:13 | 只看该作者

Same question as OP. Isn't the payer of the rate the borrower? So if you are paying a floating rate interest, aren't you borrowing at that rate?

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