Neutralize Volatility with Interest Rate Swaps
Finding the right mix of floating and long-term interest rates to fund growth or retire debt can neutralize interest rate volatility.
Finding the right mix of floating and long-term interest rates to fund growth or retire debt can neutralize interest rate volatility.
One option is an interest rate swap. A swap works as follows for a hypothetical business with a variable rate loan based on the London Inter-Bank Offered Rate (LIBOR) plus 2 percent with a bank.
In the first leg of the swap, the bank sends a payment to the client to cover the monthly cost of the client's short-term variable rate loan, valued at LIBOR plus two 2 percent.
In the second leg, the client makes that payment to the bank's loan servicing department. This process effectively cancels the net exposure of the original loan.
In the third leg, the bank determines the market rate for a longer-term interest rate swap, such as a 4 percent fixed rate at 10 years. The client then pays that monthly swap cost to lock in the lower rate.
