DEFINITION of 'Accrual Swap'

An accrual swap is a type of interest rate swap in which the interest on one side accrues only if certain conditions are met. Payment of interest in the accrual swap occurs if the reference rate, such as the London Interbank Offered Rate (LIBOR) or Euro Interbank Offer Rate (EURIBOR), is above or below a certain level. One party pays the standard floating reference rate and, in turn, receives the reference rate plus a spread. Interest payments to the counterparty will only accrue for days in which the reference rate stays within a certain range.

Most accrual swaps use one month, two month, six month or 12 month LIBOR for the reference rate, although accrual swaps can be done using treasury rates like the 10 year. The range itself must be determined in advance and may be fixed for the life of the swap. However, depending on the type and terms of the accrual swap, the rate range can be reset after set periods of time, usually on the coupon date. Accrual swaps are also referred to as corridor accrual swaps or range accrual swaps.

BREAKING DOWN 'Accrual Swap'

An accrual swap is sometimes described as a combination of an interest rate swap and a pair of binary options that set a floor and a cap, as no interest accrues if the reference rate is above the cap or below the floor. Investors and companies utilizing accrual swaps are essentially betting that the reference rate will stay in a certain range. As long as the reference rate stays in the predefined range, interest is not accrued. The broader the lower floor and upper cap, the greater the chances that the reference rate will fall within this range.

Types of Accrual Swaps

Accrual swaps come in a variety of types that are tailored to the type of protection and exposure the two parties are looking for. A callable range accrual swap, for example, can be called on any coupon date by the party paying the accrual coupon after an initial lock-out period has passed. In a floating rate accrual swap, the reference range floats in that it is set anew at each accrual period, moving up or down with the reference rate. There are even one-touch accrual swaps - or binary accrual swaps - where any movement outside of the set range cancels all future accruals.   

In addition to interest rate accrual swaps, there are other range bound derivatives that can use equity indexes, commodity prices and other reference rates in addition to interest rates. These trading products with wider or even multiple reference rates are usually referred to as range accruals.

RELATED TERMS
  1. Asset Swap

    An asset swap is a derivative contract through which fixed and ...
  2. Swap Curve

    A swap curve identifies the relationship between swap rates at ...
  3. Absolute Rate

    The absolute rate is the fixed portion of an interest rate swap, ...
  4. Swap Bank

    A swap bank is an institution that acts as a broker to two unnamed ...
  5. Modified Accrual Accounting

    Modified accrual accounting is an accounting method commonly ...
  6. Floating Price

    The floating price is a leg of a swap contract that depends on ...
Related Articles
  1. Investing

    How To Decipher Accrual Accounting

    Accrual accounting is an important method of measuring the performance and position of a company. Learn more on how its used.
  2. Managing Wealth

    An In-Depth Look at the Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  3. Investing

    How To Read Interest Rate Swap Quotes

    Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes
  4. Trading

    How To Value Interest Rate Swaps

    An interest rate swap is a contractual agreement between two parties agreeing to exchange cash flows of an underlying asset for a fixed period of time.
  5. Trading

    Different Types of Swaps

    Identify and explore the most common types of swap contracts. Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific ...
  6. Investing

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  7. Investing

    The Fast-Paced World of Libor & Fixed Income Arbitrage

    LIBOR is an essential part of implementing the swap spread arbitrage strategy for fixed income arbitrage. Here is a step-by-step explanation of how it works.
RELATED FAQS
  1. When are businesses required to use accrual accounting?

    Determine when the accrual accounting method must be used instead of cash accounting. Most businesses use accrual accounting ... Read Answer >>
  2. What is the difference between derivatives and swaps?

    Swaps comprise just one type of the broader asset class called derivatives. Read Answer >>
  3. When was the first swap agreement and why were swaps created?

    Learn about the history of swap agreements, the first swap agreement between IBM and the World Bank, and how swaps have evolved ... Read Answer >>
  4. How does accrual accounting differ from cash basis accounting?

    The accrual and cash-basis methods recognize revenue and expenses at different times. In this article, we analyze the advantages ... Read Answer >>
  5. What is the difference between accrual accounting and cash accounting?

    Understand the differences between the two basic methods of accounting commonly used by businesses: cash accounting and accrual ... Read Answer >>
  6. What is a Debt for Equity Swap?

    Learn why companies issue debt for equity swaps, what they are, and how they impact shareholders and debt holders. Read Answer >>
Trading Center