DEFINITION of 'Interest Rate Swap'
An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps often exchange a fixed payment for a floating payment that is linked to an interest rate (most often the LIBOR). A company will typically use interest rate swaps to limit or manage exposure to fluctuations in interest rates, or to obtain a marginally lower interest rate than it would have been able to get without the swap.
INVESTOPEDIA EXPLAINS 'Interest Rate Swap'
Interest rate swaps are simply the exchange of one set of cash flows (based on interest rate specifications) for another. Because they trade OTC, they are really just contracts set up between two or more parties, and thus can be customized in any number of ways.
Generally speaking, swaps are sought by firms that desire a type of interest rate structure that another firm can provide less expensively. For example, let's say Cory's Tequila Company (CTC) is seeking to loan funds at a fixed interest rate, but Tom's Sports Inc. (TSI) has access to marginally cheaper fixedrate funds. Tom's Sports can issue debt to investors at its low fixed rate and then trade the fixedrate cash flow obligations to CTC for floatingrate obligations issued by TSI. Even though TSI may have a higher floating rate than CTC, by swapping the interest structures they are best able to obtain, their combined costs are decreased  a benefit that can be shared by both parties.
VIDEO

Municipal Bond Arbitrage
A strategy that consists of building a portfolio of taxexempt ... 
Swap Transferring Risk With Participating ...
A specific type of hedging technique. STRIPEs combine interest ... 
Notional Principal Amount
In an interest rate swap, the predetermined dollar amounts on ... 
Overnight Index Swap
An interest rate swap involving the overnight rate being exchanged ... 
Total Return Swap
A swap agreement in which one party makes payments based on a ... 
Basis Rate Swap
A type of swap in which two parties swap variable interest rates ...

For what financial instruments is a modified duration relevant?
The modified duration is a formula used to calculate the percent change in the price of a financial instrument when there ... Read Full Answer >> 
How big is the derivatives market?
The derivatives market is, in a word, gigantic, often estimated at more that $1.2 quadrillion. Some market analysts estimate ... Read Full Answer >> 
What does the notional principal of a derivative contract refer to?
The notional principal amount of a derivative refers to the nominal, or predetermined, value used to calculate payments made ... Read Full Answer >> 
How does an entrepreneur choose a business structure?
Swaps are derivative contracts between two parties that involve the exchange of cash flows. Interest rate swaps involve exchanging ... Read Full Answer >> 
What are some common markets where notional value is used?
Notional value is commonly used in futures and swap markets. The notional value is the total net amount of derivative contracts, ... Read Full Answer >> 
How can an investor reduce interest rate risk?
Investors can reduce interest rate risk with forward contracts, interest rate swaps and futures. Investors may desire reduced ... Read Full Answer >> 
Can individual investors profit from interest rate swaps?
Interest rate swaps normally take place between two business entities, but individual investors can still use them to speculate ... Read Full Answer >> 
If interest rate swaps are based on two companies' different outlook on interest ...
Interest rate swaps are, at their core, a derivative instrument built on the premise of comparative advantage. To see how ... Read Full Answer >> 
Can bond traders trade on interest rate swaps?
The vast majority of traders performing interest rate swaps in the bond market tend to be large financial institutions, not ... Read Full Answer >> 
Who determines interest rates?
In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of ... Read Full Answer >> 
How can I use an "airbag swap"?
An airbag swap is an interest rate swap designed to provide a cushion against rising interest rates. The airbag swap originally ... Read Full Answer >> 
How do companies benefit from interest rate and currency swaps?
An interest rate swap involves the exchange of cash flows between two parties based on interest payments for a particular ... Read Full Answer >>

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. 
Economics
Forces Behind Interest Rates
Get a deeper understanding of the importance of interest rates and what makes them change. 
Options & Futures
An Introduction To Swaps
Learn how these derivatives work and how companies can benefit from them. 
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. 
Forex Education
The Ins And Outs Of Corporate Eurobonds
Corporate eurobonds simplify expansion for MNCs, though there are a few more hoops to jump through. 
Investing Basics
What Does Spot Price Mean?
Spot price is the current price at which a security may be bought or sold. 
Investing Basics
What Does a Clearing House Do?
A clearing house is a thirdparty agency or separate entity that acts as a gobetween for buyers and sellers in financial markets. 
Technical Indicators
Using Bullish Candlestick Patterns To Buy Stocks
These five popular candlestick chart patterns signal a bullish reversal in downtrend. 
Trading Strategies
Profitable LongTerm Consolidation Patterns
Longterm consolidation patterns set up high reward opportunities for patient market players. 
Investing Basics
What is Meant by Implied Volatility?
The estimated volatility of a security's price.