Interest Rate Swap

Product Description
An INTEREST RATE SWAP or 'IRS' is the most widely used mechanism in managing interest rates on longer term loans. An IRS allows the company to swap their floating interest cost to a fixed interest cost for the period of the loan. In this way, the firm is protected against any rise in floating interest rates. It is an interest rate contract whereby the customer pays a predetermined fixed rate for each of the interest periods during the life of the contract. In return, the customer receives floating rate determined at the beginning of each of the interest period to meet the liability on the loan interest. This allows the customer to convert fixed rate liability to floating rate or vice versa, depending on view of future market movement.

Risk Benefit Analysis

What are the benefits? • From a floating to fixed contract, the customer will know the exact future cash flow for every payment period. In addition, the customer is protected against interest rate increases. • From a fixed to floating contract, the customer can reduce funding cost if interest rate declines. What are the risks? • From a floating to fixed contract, the customer does not enjoy the downside when interest rate declines. • From a fixed to floating contract, the customer may pay higher interest rate if interest rate went the opposite way, i.e. interest rises higher than expected.

Cross Currency Swap

Product Description
A Cross Currency Swap is an agreement between two parties to exchange, or swap future interest payments based on a notional principal in one currency for similar payments in another currency. Customers can convert their fixed rate liabilities for a floating rate contract or vice versa, depending on their views of future market movements. Interest payments are typically based against a floating rate index such as USD LIBOR. Interest payments from the opposite direction are based upon a fixed rate or another floating rate index denominated in a different currency. Conventionally, there is an initial and final exchange of principal.

Risk Benefit Analysis

What are the benefits? • The customer can reduce the FX exposure between income currency and interest payment currency • Both FX and interest rate exposures are hedged. What are the risks? • From a floating to fixed contract, the customer does not enjoy the downside when interest rate declines. • From a fixed to floating contract, the customer may pay higher interest rate if interest rate went the opposite way, i.e. interest rises higher than expected. • Same risk applies to the FX rate of the two currencies.

Participating Swap

Product Description
A participating swap is a swap that has the combination of the fixed and floating payments. However, the payment is capped at a certain rate. This structure can be used to reduce the funding cost if customer takes a view that the interest rate will not go beyond a certain level.

Risk Benefit Analysis

What are the benefits? • Protection against rising interest rate. • All-in cost is capped even if interest rate rises. What are the risks? • Capped cost is higher than plain IRS.

Subsidising Swap

Product Description
A subsidising swap is a swap that has the combination of fixed and floating payments. If floating rate index is fixed below strike, the customer pays fixed rate. Otherwise, customer gets subsidy by paying floating rate index minus spread. This structure can be used to reduce the funding cost if customer takes a view that the interest rate will not rise higher than the pre-determined level.

Risk Benefit Analysis

What are the benefits? • The customer pays a lower rate than the market fixed rate at the inception of the contract as long as the floating rate is lower than the pre-determined level. • Even if floating rate is higher than the pre-determined level, customer gets a subsidy. What are the risks? • Customer is exposed if floating rate is significantly higher than the pre-determined level.

Knock-out IRS

Product Description
A knock-out IRS is a normal IRS but the IRS will be terminated once the fixing index e.g. 6 month HKD HIBOR is above the knock-out rate. This structure is suitable for a customer who takes a view that the floating index will not trade above knock-out rate.

Risk Benefit Analysis

What are the benefits? • Customer pays a lower fixed rate if the knock-out rate is not breached. What are the risks? • No more protection against rising interest rates once knock-out rate is breached.

Interest Rate Cap

Product Description
An Interest Rate Cap is an interest rate contract whereby a hedger of a loan exposure can pay a pre-determined fixed rate for each of the interest period during the life of the contract if floating rates fixed at the beginning of each of the interest period is higher than a pre-determined fixed strike rate. It is a protection on the maximum interest rate pays out on the liability. To enjoy this protection, the hedger has to pay an option premium upfront.

Risk Benefit Analysis

What are the benefits? • If USD interest rates go up, then the hedger is protected at the contract strike rate which is lower than the prevailing USD LIBOR rate. • If USD interest rates stay at low levels, then the hedger can pay the low prevailing USD LIBOR rates. What are the risks? • If USD interest rates go up, the pre-determined strike rate of an Interest Rate Cap is higher than the USD swap rates for the corresponding liability. • The hedger has to pay an option premium no matter the protection will be used or not.

Capped Arrear Reset Swap

Product Description
A Capped Arrear Reset Swap is an interest rate swap whereby a hedger of a loan exposure receives a floating rate fixed at the beginning of each interest period and pays a floating rate plus/minus a fixed pre-set spread at the end of each corresponding period. The rate paid by the customer is always capped by a pre-determined maximum level. The incentive to enter into this swap is either to hedge against the customer’s cash flows at a protection level (subject to market condition) at no upfront cost.

Risk Benefit Analysis

What are the benefits? • A lower interest rate is paid if HIBOR rates go down and stay at low levels. • If rates go up substantially, rates paid will be subject to a maximum pre-determined level. What are the risks? • If rate goes up, 6 month arrear HIBOR rates paid will be higher than the regular 6 Month HIBOR rates.