Interest-Rate Derivative

AAA

DEFINITION of 'Interest-Rate Derivative'

A financial instrument based on an underlying financial security whose value is affected by changes in interest rates. Interest-rate 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 interest-rate derivatives as a speculative tool - they hope to profit from their guesses about which direction market interest rates will move.

INVESTOPEDIA EXPLAINS 'Interest-Rate Derivative'

A plain vanilla interest-rate swap is the most basic type of interest-rate 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 interest-rate derivatives include eurostrips, swaptions and interest rate call options, to name just a few.

RELATED TERMS
  1. Reference Entity

    One of the underlying parties involved in a credit derivative ...
  2. Credit Derivative

    Privately held negotiable bilateral contracts that allow users ...
  3. Price Swap Derivative

    A derivative transaction in which one party guarantees a fixed ...
  4. Derivative

    A security whose price is dependent upon or derived from one ...
  5. Equity Derivative

    A derivative instrument with underlying assets based on equity ...
  6. Inflation Derivatives

    A subclass of derivative that is used by individuals to mitigate ...
Related Articles
  1. Options & Futures

    Careers In The Derivatives Market

    The growing interest in and complexity of these securities means opportunities for job seekers.
  2. Investing Basics

    The Barnyard Basics Of Derivatives

    This tale of a fictional chicken farm is a great way to learn how derivatives work in the market.
  3. Mutual Funds & ETFs

    The Alphabet Soup Of Credit Derivative Indexes

    Find out how these instruments work and how they are used in the market.
  4. Options & Futures

    Are Derivatives Safe For Retail Investors?

    These vehicles have gotten a bad rap in the press. Find out whether they deserve it.
  5. Active Trading

    How Companies Use Derivatives To Hedge Risk

    Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices.
  6. Investing Basics

    The Most Popular Bitcoin Mining Software

    Success at mining bitcoins depends on the combination of time, knowledge, computer hardware and the complementary software.
  7. When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps.
    Investing Basics

    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.
  8. Mutual Funds & ETFs

    What is the difference between a hedge fund and a private equity fund?

    Learn the primary differences between hedge funds and private equity funds, both of which are utilized by high net worth investors.
  9. With stocks surging, financial advisers and their wealthy clients are asking why they should continue to bother with poorly performing alternatives.
    Professionals

    Are Advisors Off Alternatives?

    With stocks surging, financial advisers and their wealthy clients are asking why they should continue to bother with poorly performing alternatives.
  10. Mutual Funds & ETFs

    Where does a hedge fund get its money?

    Learn how a hedge fund is structured and how the managing partner of the fund goes about the process of finding and soliciting investors.

You May Also Like

Hot Definitions
  1. Commodity

    1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often ...
  2. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  3. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  4. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  5. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  6. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
Trading Center