Assume that a firm has a floating rate debt and a low credit rate. How can it use a swap rate agreement with a
counterparty to achieve a fixed rate payment?

Question

BlackTom AI · Accepted Answer

The scenario involves a firm with floating-rate debt and a low credit spread, seeking to lock in a fixed payment via a swap.
Option a: It can pay a floating rate and receive a floating rate. This would leave the net cash flows unchanged with respect to the debt and does not convert floating debt into a fixed stream. It does not achieve the goal of fixing the rate since both legs are floating.
Option b: It can pay a floating rate and receive a fixed rate. In this case, the firm would still be exposed to floating-rate payments on its debt plus the swap’s fixed receive; the net result would be a mismatch where the cash outflow could vary if the floating leg changes. This setup would not convert to a fixed payment for the firm.
Option c: It can pay a fixed rate and receive a fixed rate. A fixed-for-fixed swap would not change the nature of the debt’s exposure; it would merely swap one fixed rate for another fixed rate, failing to address the floating-rate debt exposure with a fixed-equivalent payment.
Option d: It can pay a fixed rate and receive a floating rate. This arrangement precisely hedges floating-rate debt by converting the floating obligation into a fixed payment net of the swap’s floating receipts. Since the firm’s debt is floating and its credit rate is low, paying fixed via the swap and receiving floating effectively fixes the cash outflow while offsetting some of the floating risk with the swap’s floating receipt, achieving the desired fixed-rate payment on net.
Therefore, the combination that achieves a fixed-rate payment through a swap is paying fixed and receiving floating.

BFC3240 - S2 2025 Mock Exam

Assume that a firm has a floating rate debt and a low credit rate. How can it use a swap rate agreement with a counterparty to achieve a fixed rate payment?

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