# Interest rate swap 2 | Finance & Capital Markets | Khan Academy

##### Created by Sal Khan.

In the last video company a took out a \$1mn loan from lender 1 at a variable interest rate and company b took out a fixed rate \$1mn loan from lender 2. and then they entered into this swap agreement where company a pays a fixed 7% every period. 7% on a notional 1mn. notional meaning that the 1mn doesn’t exchange hands, only the interest does. a pays the 7% on the notional

1mn every period to b. b pays libor + 1% on that notional 1mn every period to a. what i am going to do in this video is go through the numerical mechanics to show that in effect, company a now has a fixed rate loan when you think of it from the point of view the interest it is paying they have kind of swapped the fixed and variable natures of their loans. so lets think

About what happens with company a in period 1. so it had to pay in period 1, comapny a had to pay \$70,000 to lender 1 but now thats not all it has to do. definitely it still has to do that. this loan is still in effect. but now it also has to pay 7, has to pay 7% fixed to b on that notional 1mn so it also has to pay \$70,000(7% on a mn) to company b, but in exchange for

That, it’s going to get libor +1% from b. so its going to get libor (we are assuming it is 5% in period1). \$60k from b. so net net it pays 70, it pays 70 twice but then it gets back 60. so its paying \$80,000. so the net is paying \$80,000. now think about what happens in period 2 when libor changes. and so a will have to pay 4% + the 2% on its loan which is 6% or \$60,000.