Here we explore some practical applications of interest rate swaps. Starting with how they can hedge floating rate debt to create a synthetic fixed rate loan. Imagine a company that has taken out a floating rate loan based on EURIBOR, which means the interest rate they pay will change as EURIBOR rates fluctuate. This loan is priced at EURIBOR plus 1.5%, so the company's borrowing costs will vary with changes in EURIBOR.

To manage this interest rate risk and establish more predictable cash flows, the company can enter into an interest rate swap with a market maker. In this scenario, the market maker quotes a swap rate of 3.7%. This arrangement means the company will pay a fixed rate of 3.7% to the market maker, and in return receive a floating rate based on EURIBOR. By doing so, the company offsets its floating rate loan payments, and effectively converts its liability into a fixed rate liability. Creating a synthetic fixed rate loan. The company receives EURIBOR and pays EURIBOR, so they cancel out. It leaves them with a fixed payment of 3.7% plus 1.5%. Now let's look at the table to see how this swap impacts the company's all in borrowing costs across various EURIBOR levels.

The first column shows EURIBOR rates ranging from 0% to 7%. The second column calculates the loan rates based on EURIBOR plus the agreed margin of 1.5%. For example, if EURIBOR is 0%, the loan rate is 1.5%. As EURIBOR rises, so does the loan rate. At a EURIBOR rate of 4%, the loan rate becomes 5.5%. The third column illustrates the swaps net payment, which varies with changes in EURIBOR. At 0% EURIBOR, the company's net swap payments is 3.7%.

Here the company pays the fixed rate of 3.7% and receives nothing. Since EURIBOR is zero. As EURIBOR rises, the net payment decreases because the company receives more from the floating rate. For instance, at a EURIBOR rate of 7%, the company's net swap payment is negative 3.3%. They pay the fixed rate of 3.7%, but receive 7% from the floating leg. Finally, the last column reveals the company's all in borrowing rates after accounting for the swaps effect. Thanks to the swap, this rate remains steady at 5.2% across all EURIBOR levels. Essentially, the swap transforms the loan into a fixed rate loan by offsetting the floating EURIBOR payments, giving the company predictability in its interest expenses.