A relatively new customer of the bank wants to hedge its exposure to variable interest rate
liabilities and has an incomplete understanding of the mechanics of an interest rate swap.
The client has indicated that it needs cash flows every six months – that are referenced to
LIBOR - to meet its floating rate payment obligations. How would you advise the client on
the mechanics and pricing of a swap and how would you explain to the client the reasons
why it might be advisable for the client to consider the receipt of 3 month LIBOR rather than
6 month LIBOR.
Your client should consider the IRS with the same floating rate as their obligation. Otherwise the client needs an extra hedge for the tenor basis risk.
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