What is a 'Basis Rate Swap'
A basis rate swap is a type of swap in which two parties swap variable interest rates based on different money markets, usually to limit interestrate risk that a company faces as a result of having differing lending and borrowing rates.
For example, a company lends money to individuals at a variable rate that is tied to the London Interbank Offer (LIBOR) rate, but they borrow money based on the Treasury Bill rate. This difference between the borrowing and lending rates (the spread) leads to interestrate risk, so by entering into a basis rate swap, where they exchange the TBill rate for the LIBOR rate, they eliminate this interestrate risk.
BREAKING DOWN 'Basis Rate Swap'
Basis rate swaps are also known as floatingfloating interest rate swaps. These types of swaps allow the exchange of interest rate payments that are based on two different interest rates. This type of contract allows an institution to turn a floatingrate into a fixed rate and are generally used for exchanging liquidity. Usually, basis rate swap cash flows are netted based on the difference between the two rates of the contact. This is unlike typical currency swaps where all cash flows include interest and principal payments.
Basis Risk
Basis rate swaps help to mitigate basis risk, which is a type of risk associated with imperfect hedging. This type of risk arises when an investor or institution has a position in a contract or security that has at least one stream of payable cash flows and at least one stream of receivable cash flows, where the factors affecting those cash flows are different than one another and the correlation between them is less than one. Basis rate swaps can help reduce the potential gains or losses arising from basis risk, and because this is their primary purpose, are typically used for hedging. But, certain entities do use these contracts to express directional views in rates, such as the direction of LIBORbased spreads, views on consumer credit quality, and even the divergence of the Fed funds effective rate versus the Fed funds target rate.
Types of Basis Rate Swaps
While these types of contracts are custom between two parties and not exchangetraded, four of the more popular basis rate swaps include LIBOR/LIBOR, Fed funds rate/LIBOR, prime rate/LIBOR, and prime rate/Fed funds rate. Payments on these types of swaps can be customized, but it is very common for the payments to occur quarterly.

Liability Swap
A liability swap is a financial derivative in which two parties ... 
Swap Rate
The swap rate is the fixed portion of a swap as determined by ... 
Foreign Currency Swap
A foreign currency swap is an agreement to exchange currency ... 
Swap
A swap is a derivative contract through which two parties exchange ... 
Rate Anticipation Swap
A type of swap in which bonds are exchanged according to their ... 
Swap Bank
A financial institution that acts as an intermediary for interest ...

Trading
Different Types of Swaps
Identify and explore the most common types of swap contracts. 
Trading
How To Value Interest Rate Swaps
Interest rate swaps are derivative instruments that enable counterparties to exchange fixed and floating cash flows. 
Trading
Hedging with currency swaps
The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it with currency swaps. 
Investing
The FastPaced 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 stepbystep explanation of how it works. 
Investing
The Advantages Of Bond Swapping
This technique can add diversity to your portfolio and lower your taxes. Find out how. 
Trading
Derivatives 101
Learn how to use derivatives to hedge, speculate or increase leverage in an investment portfolio. 
Trading
Introduction To Counterparty Risk
Unlike a funded loan, the exposure from a credit derivative is complicated. Find out everything you need to know about counterparty risk. 
Investing
Harvard Gets a Failing Grade on InterestRate Swaps
Harvard is among scores of colleges and universities spaying the price for investing in interestrate swaps that imploded during the financial crisis. 
Investing
Is Your Mutual Fund Safe?
You might be carrying more risk than you think if your fund invests in derivatives. 
Trading
5 Popular Derivatives And How They Work
These popular derivative instruments allow investors to hedge, speculate or increase leverage but weigh the risks before taking exposure.

How are swap agreements financed?
Learn how swap agreements are now cleared by swap execution facilities and require the use of collateral margin to hold, ... Read Answer >> 
What is the difference between derivatives and swaps?
Swaps comprise just one type of the broader asset class called derivatives. Read Answer >>