Fixed vs Floating Rate
A fixed-rate loan pays the same coupon for the life of the deal. A floating-rate loan resets its coupon each period to a market benchmark, in Australia typically 3-month BBSW plus a credit margin. Fixed exposure shifts price risk to the borrower's balance sheet (the loan's mark-to-market moves when yields move) while floating exposure shifts cash-flow risk (payments rise and fall with the benchmark). An interest rate swap lets a borrower convert one into the other without refinancing the underlying loan.
Why it matters
Think of a household mortgage. A fixed rate is the borrower paying a known amount every month regardless of what the RBA does. A floating rate is the borrower's payment tracking the cash rate, so the bill drops when policy eases and rises when policy tightens. Corporates face the same trade-off in larger size. The choice depends on the borrower's funding needs, rate view, and the natural sensitivity of revenue to interest rates.
Formulas
Worked examples
Australian corporate borrows A$10 million at $3\text{M BBSW} + 1.50\%$. Current 3-month BBSW = $4.00\%$, accrual period = 90 days.
Quarterly coupon = 10{,}000{,}000 \times (0.0400 + 0.0150) \times 90/365 = 10{,}000{,}000 \times 0.0550 \times 0.2466 = A\135{,}616$. If BBSW resets to $5.00\%$ next quarter, the next coupon rises to $10{,}000{,}000 \times 0.0650 \times 0.2466 = A\$160{,}273$. The credit spread of $1.50\%$ stays constant. Only the BBSW component resets.
Common mistakes
- ✗Floating is always cheaper than fixed. Not in general. The fixed rate is roughly the market's expectation of average BBSW over the loan's life plus a term premium. If rates rise faster than the forward curve, floating ends up more expensive. The borrower trades certainty for forecast risk.
- ✗Fixed-rate borrowing has no interest rate risk. The cash flow is certain, but the economic value of the loan still moves with market rates. A 5-year A$10m fixed loan at 5% loses value to the borrower (becomes a liability worth more than book) when rates fall. This matters for refinancing and balance-sheet management.
Revision bullets
- •Fixed: constant coupons, certainty on cash flow
- •Floating: coupon resets to BBSW + credit spread
- •Australian floating loans typically reference 3-month BBSW
- •Swaps convert one to the other without refinancing
- •Choice depends on rate view and revenue sensitivity
Quick check
An Australian corporate with floating-rate debt that fears rising rates can hedge by entering an interest rate swap in which it:
Connected topics
In learning paths
Sources
- Hull, John C. Options, Futures, and Other Derivatives. 11th ed. Pearson, 2022. ISBN 978-0-13-693997-9.Chapter 7 introduces vanilla interest rate swaps as a way to transform fixed into floating exposure, with explicit BBSW/LIBOR-style examples.
- Australian Securities Exchange. BBSW benchmark rate methodology. ASX, 2018 onwards.Confirms 1- to 6-month BBSW tenors, daily rate set, and the 365-day accrual convention used in Australian floating-rate notes and swaps.
- Reserve Bank of Australia. Statement on Monetary Policy. RBA, quarterly publication.Tracks the RBA cash rate, the policy anchor that BBSW prices off, and shows the spread between cash rate, BBSW, and the implied swap curve.