DEFINITION of 'LIBOR-in-Arrears Swap'
A swap in which the interest paid on a particular date is determined by that date's interest rate rather than the interest rate of the previous payment date. A swap entails the exchange of one security for another in order to change the maturity (in the case of bonds), the quality of issues (bonds or stocks), or in response to changing investment objectives. A LIBOR-in-arrears swap is a type of swap where each payment is based upon the LIBOR at the end of the payment period. This is in contrast to a traditional LIBOR swap where the interest is based on the beginning or the original interest period. Also called in-arrears swap, swap-in-arrears, reset swap, and arrears swap.
BREAKING DOWN 'LIBOR-in-Arrears Swap'
LIBOR refers to the London Interbank Offered Rate, and is the interest rate at which banks can borrow funds from other banks in the Eurocurrency market. It is the world's most widely used short-term interest benchmark. The LIBOR-in-arrears structure was introduced in the mid-1980s to enable investors to take advantage of potentially falling interest rates. It is a strategy used by investors and borrowers who are directional on the interest rates and who believe they will fall. Once the rate is defined, the rate is applied retroactively (in "arrears") to that period.