The option to enter into an interest rate swap. In exchange for an option premium, the buyer gains the right but not the obligation to enter into a specified swap agreement with the issuer on a specified future date

Swap options (swaptions)

Definition
A swaption is an option on an interest rate swap. Distinction is made between payer
swaptions and receiver swaptions. More than 90% of swaptions have European exercise.

Descripttion
·  Payer swaptions: the right but not the obligation to pay fixed rate and receive
floating rate in the underlying swap.
·  Receiver swaptions: the right but not the obligation to receive fixed and pay
floating rate in the underlying swap

Why use a swaption?
Suppose that there is uncertainty about whether interest rates will increase or decrease in
the future. Instead of using an interest rate swap, a swaption can be used to protect a firm
against the risk of higher borrowing costs, but without giving up the possible benefit of
lower interest rates

Book definitions u would be having. But i give u an example to understand swaps easily.

Suppose husband is in the private job at Ankleshwar & wife in govt job at a'bad.

They want to purchase a flat in a'bad what wife will be using & a car husband will be using.

Assuming both cost same 10 lakhs. Now they enquire for loan in their companies.

Now rates of loan for both

                              Husband              Wife

House                    11%                      6%

Car                          16%                      8%

Now if we see the cheapest loan is home loan for wife but go for aggregate effect & come to conclusion that it'll be more benificial if husband takes home loan & wife takes car loan.

Thus it is swaping of interest rates coz husband will use car but has borrowed money for House & the same situation in case of wife. So its a win win situation for both the parties.

Book definitions u would be having. But i give u an example to understand swaps easily.

Suppose husband is in the private job at Ankleshwar & wife in govt job at a'bad.

They want to purchase a flat in a'bad what wife will be using & a car husband will be using.

Assuming both cost same 10 lakhs. Now they enquire for loan in their companies.

Now rates of loan for both

                              Husband              Wife

House                    11%                      6%

Car                          16%                      8%

Now if we see the cheapest loan is home loan for wife but go for aggregate effect & come to conclusion that it'll be more benificial if husband takes home loan & wife takes car loan.

Thus it is swaping of interest rates coz husband will use car but has borrowed money for House & the same situation in case of wife. So its a win win situation for both the parties.

From Investment point of view:

Interest rates are not certain. Firm may loose on Return on Investments

if Interest Rates falls. To protect against this Risk, there is Swaption.

It is an option. You can “Block” the Interest Rates for going anymore downside.

In case it goes below a Rate [which is predetermined in Swaption] you can exercise your Option & get apply Option Rate [higher than the fallen market rate].

In case market rate are higher than the “Rate in Swaption” you need not exercise

the option [Right but not the obligation].

First know meaning for swap, u have a house at chennai and I have at Mumbai, during holiday we plan to swap our houses (i will stay in ur chennai house and you will stay in my Mumbai house) for touries visit. Benifit in this swap agreement, I can stay at chennai without any hotel expenses and similarly you can stay at Mumbai.

  Apply the same in Interest concept, I have to pay fixed interest and you have floating interest.  you deside to keep your interest rate unchange and similarly I deside to keep it floating then we both will enter in to a swap agreement.