Page 137 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Financing – Debt finance

Advantages of using interest rate swaps

 To manage fixed and floating rate debt profiles without having to
change underlying borrowing.

 To hedge against variations in interest on floating rate debt, or
conversely to protect the fair value of fixed rate debt instruments.

 A swap can be used to obtain cheaper finance. For example, it
may be cheaper to obtain floating rate finance by, say, issuing a
bond and swapping into a floating rate rather than borrowing at
floating rate directly from a bank.

Disadvantages of using interest rate swaps

 Interest rates may change in the future and the company might be
locked into an unfavourable rate.

 Creditworthiness of the bank – the company and the bank arrange
to make payments to each other for a fixed period. The company
must therefore be confident about the creditworthiness of the bank
before signing up to the swap.

129