What is a 'Swap Rate'

A swap rate is the rate of the fixed leg of a swap as determined by its particular market and the parties involved. 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 the 'Swap Rate'

Swap rates are applied to different types of swaps. An interest rate swap is the exchange of a floating interest rate for a fixed interest 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 swaps are commonly used to hedge against rising and falling interest rates. If you're interested in capitalizing on interest rates and currency movements, Investopedia's Forex Trading for Beginners Course will teach you everything you need to know to get started. You'll learn everything from how the market works to advanced order types in over five hours of on-demand video, exercises, and interactive content developed by a CFA and CMT charter holder. ]

Interest Rate Swap

In an interest rate swap, one party will be the payer and the other will be the receiver of the fixed rate. The cash flow of the fixed rate leg of the swap is set when the trade is undertaken. 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 or compounded and paid semi-annually. The rate above or below LIBOR reflects the yield curve and the 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.

Currency Swap

There are three different types of interest rate exchanges for a currency swap: (1) the fixed rate of one currency for the fixed rate of the second; (2) the fixed rate of one currency for the floating rate of the second; and (3) the floating rate of one currency for the floating rate of the second.

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 of principal, then the swap rate is simply used 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 on the parties since the exchange rate could change drastically between the start of the agreement and its conclusion.

RELATED TERMS
  1. Floating Price

    The floating price is a leg of a swap contract that depends on ...
  2. Delayed Rate Setting Swap

    A delayed rate setting swap is an exchange of cash flows, one ...
  3. Asset Swap

    An asset swap is a derivative contract through which fixed and ...
  4. Forward Swap

    A forward swap is an agreement between two parties to exchange ...
  5. Interest Rate Swap

    An agreement between two parties (known as counterparties) where ...
  6. Amortizing Swap

    An amortizing swap is an exchange of cash flows, one fixed rate ...
Related Articles
  1. 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.
  2. Investing

    What's an Interest Rate Swap?

    An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount.
  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. 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.
  5. Trading

    Hedging with currency swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it with currency swaps.
  6. Investing

    PIMCO’s Mutual Fund for Investment Grade Bonds (PTTRX)

    Explore the complicated and often arcane makeup of the PIMCO Total Return Fund, and identify the fund's management style and top five holdings.
  7. Managing Wealth

    Managing interest rate risk

    Interest rate risk is the risk that arises when the absolute level of interest rates fluctuate and directly affects the values of fixed-income securities.
  8. Investing

    A Guide To Real Estate Derivatives

    These instruments provide exposure to the real estate market without having to buy and sell property.
  9. Trading

    3 Key Markets To Follow When Trading FX

    With the increased interconnectivity of the global markets these days, it pays to understand market relationships.
  10. Investing

    Harvard Gets a Failing Grade on Interest-Rate Swaps

    Harvard is among scores of colleges and universities spaying the price for investing in interest-rate swaps that imploded during the financial crisis.
RELATED FAQS
  1. How do companies benefit from interest rate and currency swaps?

    Interest rate and currency swaps help companies manage exposure to rate fluctuations and acquire a lower rate than they would ... Read Answer >>
  2. 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 >>
  3. How does an entrepreneur choose a business structure?

    Learn more about interest rate swaps and currency swaps, how these swaps are used and the difference between interest rate ... Read Answer >>
  4. What is a debt/equity swap?

    Learn why companies issue debt/equity swaps, what they are, and how they impact shareholders and debt holders. Read Answer >>
Hot Definitions
  1. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  2. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  5. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
  6. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained in a company’s financial statements.
Trading Center