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In this video we're going to take a look at a way that companies can reduce their borrowing costs it's quite a clever way it's called a swap sadly it's not something that's directly available to retail investors because the amounts involved are fairly large, but it is an important part of how banks go about determining what for example you pay on your mortgage whether that's a fixed or variable rate and also what you ultimately get charged for loans so the swaps market is huge, and it underpins an awful lot of what goes on day to day when it comes to your basic financial needs and products so what we'll do is take a quick look at a swap how it works how banks make money from it and also one or two of the applications, and we're going to focus on interest rate swaps interest rates are thought to be on the way up the Bank of England may raise rates this year the only question is when so in financial markets companies banks will be running around wondering how to hedge an exposure to what could be rising interest rates after a period of relatively low rates okay so what is a basic swap well imagine you've got a company and the sake of argument I'll just call them company a and just to demonstrate how a swaps bank makes money I'll have two clients in my example so company a and Company B and a bit like URI they need to borrow money in order to expand they need five million each just like you might apply for a mortgage, and they have different views about interest rates so company a would like ideally to borrow at a variable rate of interest perhaps they feel that interest rates are on the way down Company B would like to pay a fixed rate of interest and that's a bit like the mortgage market some people like a fixed rate of interest over say five years some people are happy to take a variable rate of interest over the same term and Bank Santa cater to both types of mortgagee so um remember that Company A's aim is to pay variable interest on the money it borrows it's going to borrow five million company B would like to pay fixed interest on the money it borrows, and it's also going to borrow five million and these two companies don't actually know each other, and we'll see how a swaps bank can improve both their lives how swap can help okay so company a goes to its bank which rather unimaginative Li I'll call Bank a Company B goes to its bank which I'll call bank B and basically here are the terms on offer now company an is big well-known well-established company be a little smaller finds it harder to raise money so Company A goes to its bank and is offered the following the bank says if you want to borrow five million from us and pay a fixed rate of interest you'll pay a seven percent if on the other hand you'd like a 5,000,000 pound loan at a variable rate of interest you can pay us the London interbank offer rate LIBOR now that's a variable rate set by the banks between themselves that fix is the variable cost the borrowing the companies that want...
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