DEFINITION of 'InterestRate Derivative'
A financial instrument based on an underlying financial security whose value is affected by changes in interest rates. Interestrate derivatives are hedges used by institutional investors such as banks to combat the changes in market interest rates. Individual investors are more likely to use interestrate derivatives as a speculative tool  they hope to profit from their guesses about which direction market interest rates will move.
INVESTOPEDIA EXPLAINS 'InterestRate Derivative'
A plain vanilla interestrate swap is the most basic type of interestrate derivative. Under such an arrangement, there are two parties. Party one receives a stream of interest payments based on a floating interest rate and pays a stream of interest payments based on a fixed rate. Party two receives a stream of fixed interest rate payments and pays a stream of floating interest rate payments. Both streams of interest payments are based on the same amount of notional principal. Through this exchange, or swap, of cash flows, the two parties hope to reduce uncertainty and the threat of loss from changes in market interest rates. Other types of interestrate derivatives include eurostrips, swaptions and interest rate call options, to name just a few.

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