DEFINITION of 'Accrual Swap'
A form of discrete time-switch option in which the interest on one side accrues only if certain conditions are met. Payment of interest in the accrual swap occurs if the reference rate, such as LIBOR or EURIBOR, is above or below a certain level. One party pays the standard floating reference rate, and in turn receives the reference rate plus a spread. Interest payments to the counterparty will only accrue for days in which the reference rate stays within a certain range.
BREAKING DOWN 'Accrual Swap'
Investors and companies utilizing accrual swaps assume the risk that the reference rate will stay in a certain range. The broader the lower and upper cap, the greater the risk that the reference rate will fall within this range, which is typically what is desired since interest will not be accrued.
For example, a company with a floating-rate obligation denominated in euros wants to hedge its exposure by paying a fixed rate which is below the market rate. The floating rate is conditional on how many days EURIBOR is within an agreed upon range during a set period. The goal of the company is to obtain a lower fixed rate by assuming the risk that the EURIBOR rate will fall outside of the agreed upon range.