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Interest Rate Swap
What Is an Interest Rate Swap?
An interest rate swap is a financial agreement between two parties to exchange interest payment obligations, typically swapping a fixed interest rate for a variable rate or vice versa.
Why It Matters
Interest rate swaps help businesses and financial institutions manage risk, reduce borrowing costs, or align their interest exposure with financial goals.
How Interest Rate Swap Works
The process involves:
- two parties agreeing to exchange payments
- one pays fixed interest
- the other pays variable interest
- payments are calculated based on a notional amount
- no principal is exchanged
Example
A company with a variable-rate loan swaps payments with another company to lock in a fixed rate.
Interest Rate Swap vs Loan
- Swap exchanges interest obligations.
- Loan involves borrowing money.
FAQs About Interest Rate Swap
Who uses swaps?
Corporations, banks, and institutional investors.
Is principal exchanged?
No, only interest payments.
Why use a swap?
To manage interest rate risk.
Related Terms
