What is a 'Swap Rate'
A swap rate is the rate of the fixed leg of a swap as determined by its particular market. In an interest rate swap, it is the fixed interest rate exchanged for a benchmark rate such as LIBOR plus or minus a spread. It is also the exchange rate associated with the fixed portion of a currency swap.
BREAKING DOWN 'Swap Rate'
An interest rate swap is the exchange of a floating rate for a fixed rate; a currency swap is the exchange of interest payments in one currency for those in another. In both types of transaction, the fixed element is referred to as the swap rate.
Interest Rate Swap
Parties are referred to with respect to the fixed rate leg of the swap; they are either payer or receivers of fixed. The cash flow of the fixed rate leg of the swap is set when the trade is done. The cash flow for the floating rate leg is set periodically on the rate reset dates, which are determined by the reset period of the floating rate leg. The most common index for the floating rate leg is the three-month U.S. dollar LIBOR. This can either be paid quarterly, so every three months, or compounded and paid semi-annually. The spread above or below LIBOR reflects both the yield curve and any credit spread to be charged. Interest rate payments between the fixed and the floating rate legs are netted at the end of each payment period, and only the difference is exchanged.
There are three different types of interest rate exchanges for a currency swap: (1) the fixed rate of one currency for a fixed rate of the second; (2) the fixed rate of one currency to a floating rate of the second; and (3) the floating rate of one to a floating rate of the second. Within each of those three variations, there are two additional variations: the swap can include or exclude a full exchange of the principal amount of currency at both the beginning and the end of the swap. The interest rate payments are not netted because they are calculated and paid in different currencies.
Regardless of whether the principal is exchanged, a swap rate for the conversion of the principal must be set. If there is no exchange, then this is used simply for the calculation of the two notional principal currency amounts on which the interest rate payments are based. If there is an exchange, where the swap rate is set can have a large profit or loss impact between the start and end dates of the swap.