Interest rate swap 1

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Interest rate swap 1

Let's say that we've got company A over here, and it takes out a $1 million loan, and it pays a variable interest rate on that loan.

It pays LIBOR plus 2%.

And LIBOR stands for London Interbank Offer Rate.

It's one of the major benchmarks for variable interest rates.

And so it pays that to some lender.

This is the person who lent company A the money.

It pays them a variable interest rate every period.

So for example, in period one if LIBOR is at 5%, then in that period, company A will pay 7%, or $70,000 to the lender in that period.

In period two, if LIBOR goes, let's say LIBOR goes down a little bit to 4%, then company A is going to pay 4 plus 2, which is 6%, which is $60,000 in interest.

Let's say that we have another company, company B, right over here.

It also borrows $1 million, but it borrows it at a fixed rate.

Let's say it borrows it at a fixed rate of 8%.

So in each period, regardless of what happens to LIBOR or any other benchmark - so this is to probably another lender, or different lender, than the person that A borrowed it from.

And it could be a bank, or it might be another company, or an investor of some kind.

We will call this Lender 1 and Lender 2.

So regardless of the period, right now company B will pay 8% of $1 million in each period, which is about $80,000, or exactly $80,000, each period.

Now let's say that neither of these parties are really happy with that situation.

Company A doesn't like the variability, the unpredictability in what happens to LIBOR, so they can't plan for how much they have to pay.

Company B feels like they're overpaying for interest.

They feel like, wow, the people who are doing variable interest rates, they're paying a less amount of interest every period.

And maybe they also, company B also, thinks that interest rates are going to go down, or that short term, or that variable rate is going to go down, LIBOR is going to go down.

So that's an even bigger reason why they want to become a variable rate borrower.

So what they can do, and neither of them can get out of these lending agreements, but what they can do is agree to essentially swap some or all of their interest rate payments.

So for example, they can enter into an agreement, and this would be called an interest rate swap, where company A agrees to pay B - maybe, let's make up a number here - 7% on a notional $1 million loan.

So, the $1 million will never change hands, but company A agrees to pay B 7% of that notional $1 million, or $70,000 per period.

And in return, company B agrees to pay A a variable rate.

Let's say it's LIBOR plus 1%, right over here.

And this little agreement - and they agreed they would agree to do this for some amount.

And once again, this is LIBOR plus 1% on a notional $1 million.

And that word notional just means that $1 million will never change hands, and they're just going to exchange the interest payments on $1 million.

And this agreement right over here is called an interest rate swap.

And I'll leave you there.

In the next video, we'll actually go through the mechanics to see that A is truly now paying a fixed rate when you put in all of their different payments into both the swap and the lender, and Company B, after entering into this swap agreement, is now really paying a variable interest rate.

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Interest rate swap 1발음듣기

다른 번역문 등록

Let's say that we've got company A over here, and it takes out a $1 million loan, and it pays a variable interest rate on that loan.발음듣기

다른 번역문 등록

It pays LIBOR plus 2%.발음듣기

다른 번역문 등록

And LIBOR stands for London Interbank Offer Rate.발음듣기

다른 번역문 등록

It's one of the major benchmarks for variable interest rates.발음듣기

다른 번역문 등록

And so it pays that to some lender.발음듣기

다른 번역문 등록

This is the person who lent company A the money.발음듣기

다른 번역문 등록

It pays them a variable interest rate every period.발음듣기

다른 번역문 등록

So for example, in period one if LIBOR is at 5%, then in that period, company A will pay 7%, or $70,000 to the lender in that period.발음듣기

다른 번역문 등록

In period two, if LIBOR goes, let's say LIBOR goes down a little bit to 4%, then company A is going to pay 4 plus 2, which is 6%, which is $60,000 in interest.발음듣기

다른 번역문 등록

Let's say that we have another company, company B, right over here.발음듣기

다른 번역문 등록

It also borrows $1 million, but it borrows it at a fixed rate.발음듣기

다른 번역문 등록

Let's say it borrows it at a fixed rate of 8%.발음듣기

다른 번역문 등록

So in each period, regardless of what happens to LIBOR or any other benchmark - so this is to probably another lender, or different lender, than the person that A borrowed it from.발음듣기

다른 번역문 등록

And it could be a bank, or it might be another company, or an investor of some kind.발음듣기

다른 번역문 등록

We will call this Lender 1 and Lender 2.발음듣기

다른 번역문 등록

So regardless of the period, right now company B will pay 8% of $1 million in each period, which is about $80,000, or exactly $80,000, each period.발음듣기

다른 번역문 등록

Now let's say that neither of these parties are really happy with that situation.발음듣기

다른 번역문 등록

Company A doesn't like the variability, the unpredictability in what happens to LIBOR, so they can't plan for how much they have to pay.발음듣기

다른 번역문 등록

Company B feels like they're overpaying for interest.발음듣기

다른 번역문 등록

They feel like, wow, the people who are doing variable interest rates, they're paying a less amount of interest every period.발음듣기

다른 번역문 등록

And maybe they also, company B also, thinks that interest rates are going to go down, or that short term, or that variable rate is going to go down, LIBOR is going to go down.발음듣기

다른 번역문 등록

So that's an even bigger reason why they want to become a variable rate borrower.발음듣기

다른 번역문 등록

So what they can do, and neither of them can get out of these lending agreements, but what they can do is agree to essentially swap some or all of their interest rate payments.발음듣기

다른 번역문 등록

So for example, they can enter into an agreement, and this would be called an interest rate swap, where company A agrees to pay B - maybe, let's make up a number here - 7% on a notional $1 million loan.발음듣기

다른 번역문 등록

So, the $1 million will never change hands, but company A agrees to pay B 7% of that notional $1 million, or $70,000 per period.발음듣기

다른 번역문 등록

And in return, company B agrees to pay A a variable rate.발음듣기

다른 번역문 등록

Let's say it's LIBOR plus 1%, right over here.발음듣기

다른 번역문 등록

And this little agreement - and they agreed they would agree to do this for some amount.발음듣기

다른 번역문 등록

And once again, this is LIBOR plus 1% on a notional $1 million.발음듣기

다른 번역문 등록

And that word notional just means that $1 million will never change hands, and they're just going to exchange the interest payments on $1 million.발음듣기

다른 번역문 등록

And this agreement right over here is called an interest rate swap.발음듣기

다른 번역문 등록

And I'll leave you there.발음듣기

다른 번역문 등록

In the next video, we'll actually go through the mechanics to see that A is truly now paying a fixed rate when you put in all of their different payments into both the swap and the lender, and Company B, after entering into this swap agreement, is now really paying a variable interest rate.발음듣기

다른 번역문 등록

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