Question

You currently borrow money at a fixed rate of 5%. However, your operating income is heavily dependent on changes in interest rates (direct relationship). You would like to reduce the volatility of your EPS and are considering interest rate swaps. Should you enter into a swap agreement where you pay a fixed rate to the bank and receive a floating rate or should you pay a floating rate to the bank and receive fixed. Explain how this will reduce the volatility of your EPS.

Answer 1

As the volatility of operating costs and the interest rate are directly proportional if the interest increases cost will also increase. From the above option on swaps agreement to reduce the volatility of the EPS, we should take the swap agreement in which we pay a floating rate to the bank and receive a fixed rate because at a constant rate of return we can able to meet any obligation which has to pay, like debt. with floating rate which we will pay to the bank will be volatile and can be managed through constant rate of return.