Interest Rate Swaps

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Akhil Agrawal

Akhil Agrawal (Querist)
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24 February 2011 What is Interest rate swaps?

CA Ravi Sisodia

CA Ravi Sisodia (Expert)
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24 February 2011 An exchange of interest payments on a specific principal amount. This is a counterparty agreement, and so can be standardized to the requirements of the parties involved. An interest rate swap usually involves just two parties, but occasionally involves more.
Often, an interest rate swap involves exchanging a fixed amount per payment period for a payment that is not fixed (the floating side of the swap would usually be linked to another interest rate, often the LIBOR).
In an interest rate swap, the principal amount is never exchanged, it is just a notional principal amount.
Also, on a payment date, it is normally the case that only the difference between the two payment amounts is turned over to the party that is entitled to it, as opposed to exchanging the full interest amounts. Thus, an interest rate swap usually involves very little cash outlay.

CA Ravi Sisodia

CA Ravi Sisodia (Expert)
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24 February 2011 An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps often exchange a fixed payment for a floating payment that is linked to an interest rate (most often the LIBOR). A company will typically use interest rate swaps to limit or manage exposure to fluctuations in interest rates, or to obtain a marginally lower interest rate than it would have been able to get without the swap.

CA Ravi Sisodia

CA Ravi Sisodia (Expert)
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24 February 2011 Contract in which two counter-parties agree to exchange interest payments of differing character based on an underlying Notional Principal amount that is never exchanged. There are three types of interest swaps: coupon swaps or exchange of fixed rate for floating rate instruments in the same currency; Basis Swaps or the exchange of floating rate for floating rate instruments in the same currency; and cross currency interest rate swaps involving the exchange of fixed rate instruments in one currency for floating rate in another.

Typically, a swap contract exchanges fixed rate obligations for a floating rate instrument in the same currency. In its simplest form, the two parties to an interest rate swap exchange their interest payment obligations (no principal changes hands) on two different kinds of debt instruments, one being a fixed interest rate, the other being a floating rate.

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