DEFINITION of 'Index Amortizing Swap - IAS'

An interest rate swap where the notional principal amount declines or is amortized when interest rates decline. An index amortizing swap (IAS) is basically an over-the-counter contract between two parties on an amortizing notional principal swap that may decrease over the life of the swap. The notional principal amortizes or declines more rapidly when short-term interest rates - indexed to LIBOR or another widely-used rate index - decline, and amortizes more slowly when short-term rates rise.

Also known as an index amortizing rate (IAR) swap or an index principal swap.

BREAKING DOWN 'Index Amortizing Swap - IAS'

In a typical index amortizing swap, a bank or insurance company receives interest payments based on a fixed rate while paying its counterparty a floating rate of interest indexed to short-term LIBOR.

The term "amortizing" in an index amortizing swap is not meant to imply payment of principal, but rather, refers to the declining notional principal amount that forms the basis for interest payments.

Index amortizing swaps are particularly useful to hedge against prepayment risk in mortgage-backed securities.

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