Interest rate swap

Interest Rate Swap – FAQs

• What is an Interest Rate Swap?

  An Interest Rate Swap is an agreement between two parties who exchange interest payments, based on a notional principal amount, over an agreed period of time. Swaps are used to assist in the management of interest rates and cash flows.
• Who would use a Swap?

  A Swap can be used by borrowers who have a desire to alter their interest rate or cash flow profile to suit their particular needs.

  Variable interest rate borrowers would use Swaps to hedge their interest costs in a market where variable interest rates are expected to rise while fixed rate borrowers would use a Swap to take advantage of lower interest rates in a market where variable interest rates are expected to fall.

  Further, borrowers may use Swaps to alter the frequency of their cash flows. For example, annual interest payments can be converted into quarterly payments or quarterly payments into semi annual cash flows. This could be beneficial when your underlying cash flows have varied.
• How does a Swap work?

  An Interest Rate Swap means that you and the Bank have agreed to exchange the net difference between two different interest rates (commonly fixed versus floating). This exchange is based upon the amount you require at the frequency you require to match your needs; for example, quarterly interest. The net difference between the two interest rates offsets the cash flows on the underlying borrowing. There is no exchange of principal.

  For example, XYZ Corporation, who has borrowed on a variable interest rate basis, has formed the view that interest rates are likely to rise. They elect to pay fixed for the remaining term of the borrowing using an Interest Rate Swap, while their underlying borrowing remains variable, but hedged. 

  In this case, the two variable cash flows offset each other, thereby achieving a fixed rate for the borrower.
• How much does a Swap cost?

  There are no fees or other direct costs associated with Interest Rate Swaps. The price of an Interest Rate Swap is simply the fixed rate of interest at which the Swap is agreed between the Bank and yourself. The fixed rate will depend on the term of the Swap, the interest frequency and current market interest rates.
• Over what period can I obtain a Swap?

  An Interest Rate Swap can be arranged for terms of one to ten years. Commencement date can vary to suit your needs.
• Can a Swap be used for future borrowings?

  Yes. A Swap can be arranged to meet the interest rate and cash flow requirements of future borrowings.

  For example our borrower, XYZ Corporation, has a fixed rate facility, which is due to rollover in six months time. Concerned that interest rates are rising, they want to secure fixed rate funding today for a further three years commencing on expiry of the current facility. XYZ enters into a three year Swap today, commencing in six months as the payer of the fixed interest rate. This Swap hedges the interest rate on the borrowing facility today giving comfort against future interest rate rises.
• Is there a minimum transaction amount for an Interest Rate Swap?

  The Bank is happy to quote on Interest Rate Swaps of $1,000,000 face value of more.
• What happens if the interest rate outlook changes after I have entered into the Swap.

  If your view on interest rates changes at any time after you have entered into the Swap you have two choices. You can terminate the Swap, in which case the Bank will calculate any residual value and either the Bank will pay you this amount or you will pay the amount to the Bank. The residual value will depend on current interest rates at the time of termination. Alternatively, you can enter into another Swap with the opposite interest rate profile to the original Swap.
• What happens if I repay my loan early? Is the Swap cancelled?

  As the Swap is totally independent of your underlying borrowings you have two choices. You may terminate the Swap as explained above or you may decide to let the Swap run until completion, in which case your obligations for payments or rights to receipts will continue in accordance with the Swap agreement.
• Are there any risks associated with an Interest Rate Swap?

  Yes. By entering into an Interest Rate Swap you have expressed your view on interest rates and how they impact your borrowings. Should interest rate movements be different to your expectations, the Swap may have the opposite effect to what you were trying to achieve with the transaction. You can however, reverse or terminate the Swap should this start to happen (remembering you may be required to pay the Bank the difference or the Bank will pay you the difference between market interest rates and the Swap rate for the remaining term of the Swap).
• What other information do I need to know?

  If you decide that Swaps are appropriate for you, the Bank will require you to sign its standard terms and conditions. These documents are easy to read as they have been written in plain English. They summarise the terms and conditions under which you agree to deal with the Bank.

  Entering into an Interest Rate Swap will also involve credit decisions by the Bank in relation to the Swap. This aspect of the transaction will be discussed with you by your St.George Financial Markets representative.
• How do I arrange a Swap?

  Simply phone your St.George Financial Markets representative to discuss your needs