## What Is the Absolute Rate?

The absolute rate, also known as the absolute swap yield, is the total yield earned by both parties to an interest rate swap.

It is calculated as the sum of the fixed and variable components of the interest rate swap. For example, if an interest rate swap has a fixed rate of 2% and a variable rate of 3%, then the absolute rate would be 5%.

### Key Takeaways

• The absolute rate is the sum of the fixed and variable rates used in an interest rate swap.
• It is also known as the absolute swap yield and is a key metric used by derivative traders.
• Interest rate swaps are a large and liquid market, useful for parties wishing to hedge or speculate on interest rate movements.

## Understanding Absolute Rates

Interest rate swaps are a type of derivative transaction in which two parties agree to exchange, or "swap," one series of cashflows for another over a set period of time.

The most commonly traded type of interest rate swap is a "plain vanilla" swap. In these contracts, one party agrees to exchange a series of cashflows based on a fixed interest rate, in exchange for a series of cashflows based on a variable interest rate, such as the London Interbank Offered Rate (LIBOR).

At the time that the interest rate swap is initiated, the two series of cashflows—one which is based on a fixed interest rate, and the other which is based on a variable interest rate—will be structured so that the two series have the same net present value (NPV). However, depending on how interest rates fluctuate after the contract is initiated, the interest rate swap may end up benefiting one party more than the other.

Users of interest rate swaps will also refer to the "swap spread." The swap spread refers to the difference between the interest rate on the fixed portion of an interest rate swap, as compared to the interest rate given by a sovereign debt security that has a similar maturity period. For example, if a 1-year sovereign bond is yielding 2.00% and the fixed portion of an interest rate swap is set at 3.00%, then the swap spread on that interest rate swap would be 1.00%.

In addition to plain vanilla swaps, there are many other types of interest swap transactions, such as ones in which the counterparties each exchange cashflows based on a variable interest rate. However, plain vanilla swaps comprise the majority of the market.