Supplementary Swap Problem
Suppose the CFO of National Grid’s firm has a lot of variable rate debt and is worried about the
possibility of rising interest rates. Procter & Gamble on the other hand has almost all of its debt
at fixed rates and is concerned about being unable to take advantage of a possible decline in
interest rates. The firms wish to swap interest payments on 200 MM of notional principal. Their
costs of borrowing are given below.
National Grid
P&G
Fixed Rate
8%
9.6%
Variable Rate
6 month T-bill + 0.4%
6 month T-bill + 2.5%
The terms of the swap are for a fixed rate of 7.4% and a variable rate equaling the 6 month T-bill
rate. Construct a swap so that both parties benefit. Show what the cash flows would be. Neglect
fees to the intermediaries.
Solution:
N. Grid:
borrow @ 6 month + 0.4%
pay 7.4%
receive 6 month
net amount
-(6 month + 0.4%)
* 200 MM
-7.4%
* 200 MM
+ 6 month
* 200 MM
7.8% * 200 MM, or a saving of 0.2%
of 200 MM = 400,000
P&G:
borrow @ 9.6%
pay 6 month
receive 7.4%
net amount
-9.6%
* 200 MM
- 6 month
* 200 MM
+7.4%
* 200 MM
-(6 month + 2.2%) * 200 MM, or a
saving of 0.3% of 200 MM
= 600,000