An absolute rate is easy to understand once you know the basics of an interest rate swap. An absolute rate is the fixed rate portion of an interest rate swap. Interest rate swap is an agreement between two parties to exchange or "swap" interest payment on loans. The most popular form of interest rate swap is the fixed to floating rate swap. (To learn more on this concept, be sure to read An Introduction To Swaps.)

Fixed to floating rate swap is when one party with fixed interest payments, swaps with another party that has floating or variable rate interest payments. Companies engage in interest rate swap as a way to minimize interest rate risk (risk that might occur due to interest rate fluctuations).

The absolute rate is expressed as a fixed percentage and not as a premium or discount to a reference rate. Reference rates are usually based on a moving index like LIBOR, and some interest rates are derived by adding a premium to the reference rate or subtracting a discount from the reference rate. It is sometimes referred to as "absolute swap yield."

The absolute rate is usually determined finding the present value of the fixed portion of the interest rate swap. The present value of the fixed portion of the interest rate swap is calculated by dividing the fixed payments by one plus the maturity rate of a U.S Treasury bond with the same maturity, raised to the maturity date of the swap. In other words, the absolute rate is equal to [Fixed Payments/(1+maturity rate)^maturity date of swap]. (For further reading about present value, see the Bond Pricing Sectionof our Advanced Bond Concepts Tutorial.)

It is important to know the absolute rate if you are planning to be involved in a swap rate. If you have a variable interest payment that you want to exchange or swap for a fixed one, it is very important to know what the fixed or absolute rate is. It would be meaningless to engage in an interest rate swap without knowing what the absolute rate is.

  1. Can individual investors profit from interest rate swaps?

    Find out how individual investors can speculate on interest rate movements through interest rate swaps by trading fixed rate ... Read Answer >>
  2. What are interest rate swaps on the OTC market?

    Learn about interest rate swaps and how they are traded over the counter, and understand the impact of Dodd-Frank on swaps ... Read Answer >>
  3. What is the difference between derivatives and swaps?

    Find out more about derivative securities, swaps, examples of derivatives and swaps, and the main difference between derivative ... Read Answer >>
  4. How are swap agreements financed?

    Learn how swap agreements are now cleared by swap execution facilities and require the use of collateral margin to hold, ... Read Answer >>
  5. When was the first swap agreement and why were swaps created?

    Learn about the history of swap agreements, the first swap agreement between IBM and the World Bank, and how swaps have evolved ... Read Answer >>
  6. What are the risks involved with swaps?

    Learn about interest rate risk and counterparty risk for interest rate swap agreements, and understand how the Dodd-Frank ... Read Answer >>
Related Articles
  1. Managing Wealth

    An In-Depth Look At The Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  2. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  3. Investing

    How To Read Interest Rate Swap Quotes

    Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes
  4. Trading

    What Warren Buffet Calls "Weapons of Mass Destruction": Understanding the Swap Industry

    A full analysis of how the swap industry works.
  5. Investing

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  6. Investing

    The Fast-Paced World of Libor & Fixed Income Arbitrage

    LIBOR is an essential part of implementing the swap spread arbitrage strategy for fixed income arbitrage. Here is a step-by-step explanation of how it works.
  7. Investing

    Harvard Gets a Failing Grade on Interest-Rate Swaps

    Harvard is among scores of colleges and universities spaying the price for investing in interest-rate swaps that imploded during the financial crisis.
  8. Investing

    Understanding Total Return Swaps

    A total return swap is a contract in which a payer and receiver exchange the credit risk and market risk of an underlying asset.
  9. Trading

    3 Key Markets To Follow When Trading FX

    With the increased interconnectivity of the global markets these days, it pays to understand market relationships.
  10. Trading

    Derivatives 101

    A derivative investment is one in which the investor does not own the underlying asset, but instead bets on the asset’s price movement with another party.
  1. Swap Rate

    The rate of the fixed portion of a swap as determined by its ...
  2. Asset Swap

    Similar in structure to a plain vanilla swap, the key difference ...
  3. Rate Anticipation Swap

    A type of swap in which bonds are exchanged according to their ...
  4. Overnight Index Swap

    An interest rate swap involving the overnight rate being exchanged ...
  5. Airbag Swap

    An interest rate swap whose notional value adjusts according ...
  6. Callable Swap

    An exchange of cash flows in which one counterparty makes payments ...
Hot Definitions
  1. Perkins Loan

    A loan program that provides low-interest student loans to undergraduate and graduate students who demonstrate exceptional ...
  2. Wealth Management

    A high-level professional service that combines financial/investment advice, accounting/tax services, retirement planning ...
  3. Assets Under Management - AUM

    The market value of assets that an investment company manages on behalf of investors. Assets under management (AUM) is looked ...
  4. Subprime Auto Loan

    A type of auto loan approved for people with substandard credit scores or limited credit histories. There is no official ...
  5. Racketeering

    A fraudulent service built to serve a problem that wouldn't otherwise exist without the influence of the enterprise offering ...
  6. Federal Debt

    The total amount of money that the United States federal government owes to creditors. The government's creditors include ...
Trading Center