What is an 'InterestRate Derivative'
An interestrate derivative is a financial instrument with a value that increases and decreases based on movements in interest rates; among the most common are interest rate swaps, caps and floors. Interestrate derivatives are often used as hedges by institutional investors, banks, companies and individuals to protect themselves against changes in market interest rates, but they can also be used to increase or refine the holder's risk profile.
BREAKING DOWN 'InterestRate Derivative'
Interest rate derivatives can range from simple to the highly complex; they can be used to reduce or increase interest rate exposure.Interest Rate Swap
A plain vanilla interest rate swap is the most basic and common type of interestrate derivative. There are two parties to a swap: 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 rate payments. Both payment streams are based on the same notional principal, and the interest payments are netted. Through this exchange of cash flows, the two parties aim to reduce uncertainty and the threat of loss from changes in market interest rates.
A swap can also be used to increase an individual or institution's risk profile, if they choose to receive the fixed rate and pay floating. This strategy is most common with companies with a credit rating that allows them to issue bonds at a low fixed rate but prefer to swap to a floating rate to take advantage of market movements.
Caps and Floors
A company with a floating rate loan that does not want to swap to a fixed rate but does want some protection can buy an interest rate cap. The cap is set at the top rate that the borrower wishes to pay; if the market moves above that level, the owner of the cap receives periodic payments based on the difference between the cap and the market rate. The premium, which is the cost of the cap, is based on how high the protection level is above the thencurrent market, the interest rate futures curve and the maturity of the cap; longer periods cost more as there is a higher chance that it will be in the money.
A company receiving a stream of floating rate payments can buy a floor to protect against declining rates. Like a cap, the price depends on the protection level and maturity.
Selling, rather than buying the cap or floor, increases rate risk.
Other Instruments
Less common interestrate derivatives include eurostrips, which are a strip of futures on the eurocurrency deposit market; swaptions, which give the holder the right but not the obligation to enter into a swap if a given rate level is reached; and interest rate call options, which give the holder the right to receive a stream of payments based on a floating rate and then to make payments based on a fixed rate.

Floating Price
The leg of a swap that is based on a fluctuating interest rate. ... 
Reversible Swap
An exchange of cash flows that allows one counterparty to use ... 
Fixed Price
The leg of a swap that is based on an unchanging interest rate. ... 
Delayed Rate Setting Swap
An exchange of cash flows, one of which is based on a fixed interest ... 
Bond Market Association (BMA) Swap
A type of swap arrangement in which two parties agree to exchange ... 
Swap Rate
The rate of the fixed portion of a swap as determined by its ...

Investing
What's an Interest Rate Swap?
An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount. 
Trading
How Are Interest Rate Swaps Valued?
When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps. 
Trading
Managing Interest Rate Risk
Interest rate risk stems from the possibility that an interestbearing assetâ€™s value will change due to changing interest rates. 
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Interest Rate Swaps Explained
Plain interest rate swaps that enable the parties involved to exchange fixed and floating cash flows. 
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Learn which tools you need to manage the risk that comes with changing rates. 
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Different Types of Swaps
Investopedia explores the most common types of swap contracts. 
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How To Read Interest Rate Swap Quotes
Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes 
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An Introduction To Swaps
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An InDepth Look At The Swap Market
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Derivatives 101
Learn how to use this type of investment as an alternative way to participate in the market.

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What is an absolute rate?
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Do interest rate swaps trade on the open market?
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