Understanding Delayed-Start Swaps in Excel

A delayed-start swap is a type of swap agreement that begins at a future date, rather than immediately after the trade date. A swap is a contract in which two parties agree to exchange cash flows or assets based on different financial instruments, such as interest rates, currencies, or commodities.

A delayed-start swap can be useful for investors who want to hedge their exposure to future changes in interest rates or exchange rates, but do not want to pay for the swap right away. For example, a company that expects to borrow money at a floating interest rate in six months may enter into a delayed-start swap today to lock in a fixed interest rate for the loan. The swap will start in six months, when the loan is taken, and the company will pay a fixed interest rate to the swap counterparty, while receiving a floating interest rate that matches the loan. This way, the company can avoid the risk of rising interest rates in the future, and know the exact cost of borrowing in advance.

A delayed-start swap is also known as a deferred swap, a forward start swap, or a forward swap. The calculation of the swap rate for a delayed-start swap is similar to that for a standard swap, except that the present value of the cash flows is discounted from the start date of the swap, rather than the trade date. A delayed-start swap can have multiple start dates, in which case the swap is divided into several sub-swaps, each with its own swap rate and cash flow schedule.

Basic Theory

A delayed-start swap is a financial contract in which two parties agree to exchange cash flows at future dates
based on a notional amount. The key feature is that the interest rate payments do not start immediately,
providing flexibility for both parties to align with their financial needs.

The two main types of cash flows in a delayed-start swap are fixed-rate payments and floating-rate payments. The
fixed rate is predetermined at the inception of the contract, while the floating rate is typically linked to a
reference interest rate index, such as LIBOR.

Procedures

1. Agreement Terms
   • Determine the notional amount: The principal on which the interest payments are calculated.
   • Set the fixed interest rate: The rate agreed upon by the parties for the fixed-rate payments.
   • Specify the reference rate: The floating-rate payments are linked to a benchmark interest rate.
2. Delayed Start
   • Decide the delay period: Specify the duration between the inception of the contract and the commencement
     of interest payments.
3. Calculation Periods
   • Establish the frequency of payments: Determine how often interest payments will be made (e.g.,
     quarterly, semi-annually).
   • Define the calculation periods: Divide the delayed-start period and subsequent periods into intervals
     for interest calculation.
4. Excel Formulas
   • Fixed Rate Payment:

     =PV(Fixed Rate, Number of Periods, 1, 0, 1)

   • Floating Rate Payment:

     =Notional * (Index Rate + Spread)

Scenario: Real-World Example

Let’s consider a delayed-start swap with the following terms:

• Notional Amount: $10,000,000
• Fixed Rate: 3.5%
• Reference Rate (LIBOR): 2.0%
• Delay Period: 6 months
• Payment Frequency: Quarterly
• Total Swap Term: 5 years

Calculation Using Excel

1. Fixed Rate Payment Calculation:

=PV(3.5%/4, 5*4, 1, 0, 1)

Result: -$9,579,035.03

2. Floating Rate Payment Calculation:

=$10,000,000 * (2.0% + Spread)

Assuming a spread of 1.5%, the result is $250,000.

Other Approaches

1. Use of Financial FunctionsUtilize Excel’s financial functions like PMT for fixed-rate payments and simple multiplication
   for floating-rate payments.
2. Scenario AnalysisPerform sensitivity analysis by altering key parameters (fixed rate, reference rate, delay period) to
   understand the impact on cash flows.