How does a Swaption work?
With a Swaption you can fix an interest rate on your future borrowings. This is via an option on a Interest Rate Swap. By acquiring the Swaption you have obtained comfort that if rates rise beyond the agreed level prior to rollover or draw down date you are insulated from these increases. If rates do not rise above the agreed rate of the Swaption you would not proceed with the Swap, instead you would borrow at the prevailing market rate. Let’s see how this would work. XYZ Corporation has a borrowing facility maturing in six months time that will require re-financing. The annual budget process for XYZ has factored in a maximum interest rate and XYZ is concerned that, prior to rollover date, rates may rise above this rate. XYZ elects to take out a Swaption. If interest rates have risen above the agreed Swap rate when the re-financing is due, XYZ would proceed with the Swap. Should interest rates on rollover date be below the Swap rate they would not proceed with the Swap and instead borr
