An interest rate swap is a type of forward contract where two parties exchange future interest payment streams based on a predetermined principal amount.
Typically, these swaps involve swapping a fixed interest rate payment for a variable one, or the other way around. This helps manage exposure to interest rate changes or allows for a slightly lower interest rate than what might be available without the swap.
Additionally, a swap can involve trading one kind of floating rate for another, which is known as a basis swap.
Learn more about Interest Rate Swap
Interest rate swaps involve swapping one type of cash flow for another. Since these trades happen over the counter (OTC), the agreements are made between two or more parties and can be tailored to meet specific needs in various ways.
Companies often use swaps when they can easily borrow money at one interest rate but would rather have a different one.
Types of Interest Rate Swaps
There are three main kinds of interest rate swaps: fixed-to-floating, floating-to-fixed, and floating-to-floating.
Conclusion
An interest rate swap is a deal where two parties agree to swap one type of interest payment for another over a set period. These are derivative contracts that are traded over the counter (OTC) and can be tailored by the involved parties to fit their financial requirements.
Typically, interest rate swaps involve exchanging fixed-rate payments for floating-rate payments, or vice versa. They’re often used to handle the risks associated with changing interest rates or to secure a better borrowing rate.