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 swaps are providing the borrower with an additional advantage of getting secured through changes in the interest rate because they will be having an additional advantage of swapping their stream of payment with another stream of payment so they can swap their fixed interest rate stream with floating interest rate stream of cash flows.

Motivation of the corporate borrower for requesting for the inclusion of interest rate swaps comes from the basic fundamental of elimination of the risk associated with interest payment because borrower will always want to have a risk elimination in association with the payment of interest so he will be trying to swap his stream of payment with another and he will try to protect himself from any increase and decrease in interest and he will be able to secure himself to a large extent like he will be trying to to swap his floating payment with fixed rate or he can also swap his fixed payment with the floating rate with another borrower.

This type of flexibility in corporate loan will be helping the borrowers in order to eliminate the risk associated to default risk and he will be able to eliminate the interest rate risk also.

For an example, if the borrower has to pay a fixed rate of interest and if the interest rate goes down, and if he has earlier ebtered into a interest rate swap, then he will be paying out the floating rate and he will be receiving the fixed rate from another swap party and he will pay the floating rate to the bank and his risk associated with interest rate will be eliminated to a large extent.