MATT BRIGIDA
Associate Professor of Finance (SUNY Polytechnic Institute) & Financial Education Advisor, Milken Institute
Say you are a portfolio manager, and you own \$100 million in long-term bonds paying a fixed 8% coupon. What would you do if you thought interest rates were going to increase?
Remember, when interest rates increase bond values decrease, so you would want to sell the bonds.
However, if you sell the bonds you incur:
This makes selling the bonds costly.
Using an Interest Rate Swap we will be able to turn your fixed rate bonds into floating rate bonds, which will maintain their value if interest rates increase.
Say you own $100,000 of 5% fixed rate debt, and you are concerned interest rates will increase. In this case you will want to swap your fixed for floating rate debt.
| Year | Floating Rate | Swap Payment | From 5% Bond | Total |
| 1 | $5000 | |||
| 2 | $5000 | |||
| 3 | $5000 | |||
| 4 | $5000 |
Notice that by receiving 5% on the debt you own, and then making the swap payment, ensures you always receive the floating rate.
Click the following links to see the code, authors of this presentation.
If you would like to make any additions or corrections to this presentation, visit our GitHub repository page to learn more about how to contribute.