How to create a derivative fixed rate loan?

Question

Just curious. Someone mentioned he can only find variable rate loans, no fixed-rate option (somewhere in Europe). Which I find strange, there has to be some price that makes such an offering viable. After all, most banks have a way to do just this.

Is it possible to construct the rough equivalent to a fixed-rate loan from other financial instruments? Naively, I thought about shorting a government bond, given that these are fixed-rate, but it doesn't work since bond prices are affected by interest rate changes.

Or, a substitute could be the composition of (1) a variable-rate loan, plus (2) some sort of insurance or another instrument that responds to interest rate changes by moving to the opposite direction (from the loan payments).

Hmm. So maybe a short sale of a government bond might do after all, so if interest rates go up, loan payments go up, but less is owed for the bond since it became cheaper. No idea how the math would work on this.

Other ideas?

Answer 1

Yes, this is (generally) what you call an Interest Rate Swap, which does exactly what you are after.

With interest rate swaps two parties trade (or swap) their interest rates (for a fixed nominal amount), typically one who already has variable rate but wants fixed and another one with the opposite attributes.

This is very common amongst institutional investors, however I am not sure that private individuals will have easy access to these derivatives.

Not sure if it is possible to construct a synthetic interest rate swap with the types of products a “normal” person has access to. Perhaps someone else can answer that :-)