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What is fixed for floating and fixed to fixed swaps?
The fixed for floating and fixed to fixed swaps are explained below −
Fixed for floating swap
Fixed for floating swap is an agreement between the parties, which involves swapping of fixed rate loan (cash flow interest) of one party to floating rate loans of other party. A company goes for fixed for floating swaps to reduce interest expenses and for match assets and liabilities that are more sensitive to floating interest rates.
Reasons to go for fixed for the floating swap are as follows −
- Reduces interest rates.
- Diversifies risk.
- Performs financial hedges (expecting decreasing of interest rates).
- Match between assets and liabilities, which are sensitive to floating interest rates.
Example
Let us say, a company W carries a loan of $150 million at fixed rate of 5.5% and expects general direction of interest rate over near and intermediate term is down. Other company U carries a loan of $150 million at LIBOR (London Interbank offer rate) and floating rate loan 3.5%. It believes interest rates are on rise. This has opposite view of company W. now company W and Company U want to swap (fixed for floating). Now, company W pay floating rate and benefits from interest drop and Company W pays fixed rate and benefits from rise in interest rate.
Fixed to fixed swap
In fixed to fixed swap agreement, both the parties agree to pay fixed interest rate on negotiated principle amount. Companies go for this, because they get loans at favourable rates and companies can buy funds in foreign currency by using the domestic currency.
Benefits of fixed to fixed swap are as follows −
- Companies can take loan at favorable rate in any of currencies.
- Companies can benefit from others countries’ interest rates.
How it works?
It takes place between different foreign entities. In this parties swap their loan principal and interest payments from once currency to another. Parties come to an agreement for paying their interest rates at a fixed rate. In this one-party agree to pay fixed interest payment in one currency for fixed interest rate in another currency. Party uses their domestic currency to buy funds in foreign currency. This gives entities to get better interest rate on loans than going directly for financing in foreign capital markets
The difference between fixed for fixed and fixed for float swaps are mentioned below −
In fixed for floating, one party pays an interest on fixed rate and other on the floating rate.
In fixed for floating principle is not exchanged.
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