1. Interest Rate Swaps Jordan Heller Chris Schubothe

2. Vocabulary Plain Vanilla Swap Most common type of swap Two parties swap fixed rate for a floating rate or vice versa Notional Principal Specified dollar amount on which the exchange interest payments are based LIBOR - London Interbank Offer Rate Determines floating interest rates Basis Points - 100 = 1%

3. Insurance Company ($40M N.P.)

4. Pays Out Claims - Actuarially computed Law of large numbers 7% on $40 Million = $2.8 Million Fixed rate

5. Receives Investments LIBOR + 160 Bp Break even = 5.4% + 160 Bp = 7% $2.8 Million Floating rate subject to change

6. Floating Rate Increases LIBOR (6%) + 160 Bp = 7.6% $3.04 Million Good Decreases LIBOR (5%) + 160Bp = 6.6% $2.64 Million Bad

7. Bank ($40M N.P.)

8. Receives Mortgage Payments/ Loan Payments 8% on $40 Million = $3.2 Million Fixed Rate

9. Pays Out Savings accounts, CD’s Interest LIBOR + 40 Bp Break Even = 7.6% + 40 Bp = 8% $3.2 Million Floating rate

10. Floating Rate Increases LIBOR (8%) + 40 Bp = 8.4% $3.36 Million Bad Decreases LIBOR (7%) + 40 Bp = 7.4% $2.96 Million Good

11. Potential Problem? Floating rates increase Good for insurance company Bad for bank Floating rates decrease Good for bank Bad for Insurance company

12. Intermediary Accepts 8% fixed from bank Pays 8% fixed to insurance company Accepts LIBOR + 160 Bp from insurance company Pays LIBOR +155 Bp to bank

13. Results Intermediary keeps 5 basis points ($20,000) Insurance company keeps 1% ($400,000) Bank keeps 115 Bp ($460,000)

15. LIBOR + 160 LIBOR + 155 8% Fixed Keeps 5 Bp $20,000

16. Intermediaries Intermediaries key to the swap Match two companies with similar needs Different notional principles - Intermediary takes a position to fill swap

17. Questions?