Description:-
An interest rate swap is an unregulated over-the-counter (OTC) derivative contract between two parties to exchange one stream of interest payments for another. These contracts are valid for a specific period and are usually used to exchange fixed-rate interest payments for floating-rate interest payments on dates specified by the parties. While fixed interest rates are determined by the expected interest rates, floating rates are pegged to a base rate such as the LIBOR (London Interbank Offered Rate).
Why are they traded?
A bank pays floating rate of interest on deposits (assets) and earns a fixed rate of interest on loans. The bank could use a fixed-pay swap (pay a fixed rate and receive a floating rate) to convert its fixed-rate loans into floating-rate assets.
Some companies have a comparative advantage in acquiring certain types of financing. For example, consider a well-known U.S. firm that wants to expand its operations into Europe, where it is less known. It will likely receive more favorable financing terms in the U.S. By then using a currency swap, the firm ends with the euros it needs to fund its expansion.
Life cycle events: –
No upfront fees. Termination fees applicable on early terminations.
Interest amounts (Fixed and floating) are exchanged depending on the frequency agreed on the trade.(e.g. daily, weekly, monthly, quarterly, yearly).
OTCWIRE 