A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:

Question

BlackTom AI · Accepted Answer

Context: A firm holds variable-rate debt, so its interest payments rise when market rates rise. The goal of a swap in this situation is to convert that variable exposure into a more predictable, fixed amount through a swap agreement.
Option A: "A. pay fixed-rate interest and receive floating rate interest." This is the classic hedging move for a borrower with floating debt: by paying fixed and receiving floating in the swap, the firm effectively converts its floating-rate obligations into fixed payments, since the floating receipts offset the variable payments on the debt. This aligns with the intent to hedge rising rates.
Option B: "B. pay floating rate and receive floating rate." Both legs are floating, so there is no net fixed-in-payment effect. The borrower would still face variability in payments, defeating the purpose of hedging against rising rates.
Option C: "C. pay floating rate and receive fixed rate." This would increase exposure to rising rates rather than decrease it. The firm would end up paying more when rates rise, which is contrary to the hedging objective for a variable-rate borrower.
Option D: "D. pay fixed rate and receive fixed rate." Both sides fixed means no rate risk is exchanged through the swap, so there is no transformation of variable debt into fixed debt. The hedge would not address the underlying floating payments of the loan.
In summary, only Option A achieves the desired conversion of a floating-rate debt obligation into a fixed.payment profile via a swap, while the other options either fail to hedge or misalign with the borrower’s objective.

A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:

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