Someone plz explain to me what is swaption (swap option)?
Thanks
Why use a swaption?
Suppose that there is uncertainty about whether interest rates will increase or decrease in
the future. Instead of using an interest rate swap, a swaption can be used to protect a firm
against the risk of higher borrowing costs, but without giving up the possible benefit of
lower interest rates
Vijay
(Adamo Studio)
(2112 Points)
Replied 11 July 2011
Book definitions u would be having. But i give u an example to understand swaps easily.
Suppose husband is in the private job at Ankleshwar & wife in govt job at a'bad.
They want to purchase a flat in a'bad what wife will be using & a car husband will be using.
Assuming both cost same 10 lakhs. Now they enquire for loan in their companies.
Now rates of loan for both
Husband Wife
House 11% 6%
Car 16% 8%
Now if we see the cheapest loan is home loan for wife but go for aggregate effect & come to conclusion that it'll be more benificial if husband takes home loan & wife takes car loan.
Thus it is swaping of interest rates coz husband will use car but has borrowed money for House & the same situation in case of wife. So its a win win situation for both the parties.
Vijay
(Adamo Studio)
(2112 Points)
Replied 11 July 2011
Book definitions u would be having. But i give u an example to understand swaps easily.
Suppose husband is in the private job at Ankleshwar & wife in govt job at a'bad.
They want to purchase a flat in a'bad what wife will be using & a car husband will be using.
Assuming both cost same 10 lakhs. Now they enquire for loan in their companies.
Now rates of loan for both
Husband Wife
House 11% 6%
Car 16% 8%
Now if we see the cheapest loan is home loan for wife but go for aggregate effect & come to conclusion that it'll be more benificial if husband takes home loan & wife takes car loan.
Thus it is swaping of interest rates coz husband will use car but has borrowed money for House & the same situation in case of wife. So its a win win situation for both the parties.
Vijay
(Adamo Studio)
(2112 Points)
Replied 11 July 2011
From Investment point of view:
Interest rates are not certain. Firm may loose on Return on Investments
if Interest Rates falls. To protect against this Risk, there is Swaption.
It is an option. You can “Block” the Interest Rates for going anymore downside.
In case it goes below a Rate [which is predetermined in Swaption] you can exercise your Option & get apply Option Rate [higher than the fallen market rate].
In case market rate are higher than the “Rate in Swaption” you need not exercise
the option [Right but not the obligation].
Premkumar VRR
(articled assistant)
(114 Points)
Replied 11 July 2011
First know meaning for swap, u have a house at chennai and I have at Mumbai, during holiday we plan to swap our houses (i will stay in ur chennai house and you will stay in my Mumbai house) for touries visit. Benifit in this swap agreement, I can stay at chennai without any hotel expenses and similarly you can stay at Mumbai.
Apply the same in Interest concept, I have to pay fixed interest and you have floating interest. you deside to keep your interest rate unchange and similarly I deside to keep it floating then we both will enter in to a swap agreement.
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