A state power utility borrows floating from banks and wants a fixed cost for five years. Should it swap the loan to fixed or refinance with a state-guaranteed fixed bond?

The swap route is cheaper: 7.80% all-in against 8.40% for the guaranteed bond, a gap of 0.60%, about Rs 18 crore a year. The swap fixes the benchmark at 7.20% and the loan margin of 0.60% sits on top. The bond's 7.90% coupon carries a 0.50% guarantee fee. The rate favours the swap; loan tenor, margin reset risk and the swap's break cost are what could change the view.

Think of a floating-rate home loan. You can ask a friend to pay your floating bill each month while you pay the friend a fixed amount, or you can take a new fixed-rate loan from another lender and close the old one. Both give you a fixed payment, but each fixed payment has its own add-ons, and the comparison only works once every add-on is in. In the swap route the interest rate swapA contract in which two parties exchange interest payments on a notional amount, typically one paying a fixed rate and the other a floating benchmark rate. cancels the floating benchmark on the loan: Suryavarta receives the benchmark from the swap bank and passes it to its lenders, and pays 7.20% fixed. The loan margin of 0.60% is not touched by the swap. In the bond route the coupon is fixed at 7.90%, and the state's guarantee fee of 0.50% is a cost of that bond existing.

Set 7.20% against 7.90% and the swap looks 0.70% cheaper. That forgets the loan margin, which flatters the swap, and forgets the guarantee fee, which flatters the bond. Here the two omissions nearly cancel, so the headline answer happens to point the right way, but a candidate who adds only one of them can flip the answer. Add the margin and not the fee and the swap route costs 7.80% against a bond at 7.90%: a 0.10% gap that sounds like a coin toss. The discipline is to write each route as one all-in number before comparing anything.

Three things sit outside the rate. First, the margin is fixed only as long as the loan. If the bank loans run three years and are refinanced at a margin of 1.20%, the swap route averages 8.04% over five years, still below 8.40% but closer. A swap fixes the benchmark, never the credit spread, so a borrower whose loans are shorter than the swap still carries spread risk. Second, a swap has a mark-to-marketThe current value of a contract if it were closed out today; for a swap it rises or falls as market rates move. value: if rates fall and Suryavarta wants to repay early, breaking the swap costs money, whereas a bond simply keeps paying its coupon. Third, the swap bank takes credit risk on the utility and may ask for collateral or use up the utility's credit line, while the bond spreads the funding across many investors and frees bank limits for working capital.

The closing line an interviewer wants: on today's numbers swap, because 7.80% beats 8.40% by Rs 18 crore a year, provided the loans run the full five years or their margin is committed. If the banks will not commit the margin, price the refinancing risk and compare again, and if the utility needs to diversify away from bank funding, the bond's extra cost buys that.