This is intended for medium or large borrowing businesses that want to change their interest rate structure by going from a variable rate structure to a fixed rate structure (or vice versa) depending on how they expect interest rates and their situation to change. They can use an interest rate swap as:

• an instrument for hedging an investment:
  • swapping a variable rate for a fixed rate;
• an instrument for hedging a loan:
  • setting the interest rate for standard credit or loans with a variable or adjustable rate (roll-over credit);
  • setting a lending rate to finance an investment that is planned but not yet carried out, etc.

For the risk of interest rate fluctuations to be hedged, the business must go from a variable interest rate to a fixed interest rate.

Presentation of the application

Explanation of the underlying financial transactions to the bank.

Guarantees

Some interest rate hedging transactions represent a credit risk for banks, causing them to analyse the applicant business and submit the application to the credit committee. It is not, however, customary for the bank to request tangible guarantees for this type of transaction.

Duration and payment

Amount

Minimum amount required.

Duration

Short to medium-term;

duration of between one and 5 years; exceptionally, up to 20 years.

Payment of a balancing amount or differential

On each due date, the variable rate is compared to the fixed rate:

• if the variable rate is higher than the fixed rate, a business that has opted for the fixed interest rate via the swap will receive an amount equal to the difference between the 2 interest rates from the counterparty;
• if the variable rate is lower than the fixed interest rate, a business that has opted for the fixed interest rate via the swap will owe the counterparty an amount equal to the difference between the 2 interest rates.

The amount to be paid is calculated on the basis of the notional amount and for the period concerned.

Set-up times

The reviewing and processing times depend on the complexity, size and urgency of the case.

Advantages, disadvantages and risks

Advantages

• the borrowing (lending) business is protected against an excessive rise (fall) in interest rates by a guaranteed maximum (minimum) rate;
• flexibility: it can be adapted to the business’ debt structure (amortisation, repayment, type of variable rate);
• possibility of reversing the transaction at any time given that it is a very liquid market and in the event of early repayment of the underlying credit;
• easy to manage, recorded off-balance sheet for the business.

Disadvantages

• no possibility of benefiting from a favourable interest rate fluctuation between the determination date and the settlement date;
• separation from the underlying loan (investment), meaning that the hedging continues to be effective even if the underlying no longer exists.

Risks

No swapping of the principal amount and therefore risk limited to the difference between interest rates.