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Interest Rate Swaps
1. Examine the contract to find the principal amount. This will be fixed and agreed-upon. Assume for this example that it is $100.
2. Calculate the first company's obligation on that amount. This, too, will generally be fixed. Assume here that it is five percent, or $5.
3. Calculate the second company's obligation. This is usually floating. Assume that this year it is six percent, or $6.
4. Subtract the lower obligation from the higher obligation. In this case, the second company owes more, so we subtract $5 from $6. The second company owes $1, or one percent of the principle this year.
Currency Swaps
5. Ensure the principal is worth the same amount in each currency by multiplying it by the exchange rate. So, if a United States and New Zealand bank are exchanging currencies at 1.5 percent, the U.S. bank needs to pay $U.S.100 and the New Zealand bank needs to spend $NZ150.
6. Calculate the first company's interest obligation. The American company has borrowed New Zealand dollars, so it needs to use the New Zealand interest rate. Assume here that it is five percent. The U.S. company owes $NZ7.50.
7. Calculate the second company's interest obligation. It has U.S. dollars, so it needs to pay U.S. interest rates. Assume the U.S. interest rates are at three percent. The NZ company owes $US3.
8. Find the exchange rate for the time of the payment. Assume that it has changed to 2.0. The NZ company still owes the U.S. company $US3. But the U.S. company is able to exchange pay is obligation of $NZ7.50 into $US3.75.
9. Subtract the smaller value from the smaller value to net the payments. This year, the U.S. company owes more. 3.75-3=0.75. The U.S. company's swap rate for this year is 75 cents, or 0.75 percent, while the NZ company's is 0.