Question

Certain features such as interest rates swaps can be included in corporate loans. Using relevant banking concept, discuss the motivation of corporate borrowers for requesting the inclusion of interest rates swaps. Give examples to illustrate your argument.

Answer 1

Interest rate swap will be providing borrowers with additional advantage of having flexibility in their loan repayment because interest rate swap will mean that there will be derivative option which is embedded with the loan which will help the borrower in order to hedge themselves against any kind of interest rate default so the borrower will be trying to exchange their fixed rate payment in place of floating rate payment or floating rate payment in place of fixed rate payment so he will be hedging himself against any kind of risk related to change in the interest rate in the economy so he will be trying to eliminate all such uncertainty is related with his payment.

interest rate swaps can be done with either floating interest rate of fixed interest rate and it will be providing the borrowers with an additional advantage of hedging there fluctuations in interest rate through taking position in derivatives contract and they will be using interest rate swaps in which they will be exchanging the fixed stream of payments with floating stream of payment or they can also exchange the floating rate payment with fixed rate Payment, so it will be providing borrowers with additional advantage of hedging themselves against risk associated with change in the rate of interest in the economy and it will mean that he is secured against any kind of interest rate change by the Federal bank and it will also mean that they will have the the advantage of of keeping themself secured against risk of financial distress.

For an example, if I am having the loan in association with fixed rate of interest payment, then if the interest rate in the economy will go low then I will be trying to take the advantage of such situation by entering into a floating rate agreement and I will be providing them with floating rate interest and I will be charging them fixed-rate interest so I will be paying those fixed rate to the lender and I will be protecting myself against any kind of default.