What Is an Interest Rate Swap Contract?
An interest rate swap contract is a legal agreement between two parties to exchange a series of interest rate payments for a designated period of time. The typical interest rate swap contract involves the exchange of a fixed interest payment for a floating interest payment.
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Characteristics
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Interest rate swap contracts are considered derivatives as the value is based off the value of an underlying instrument, and the contracts usually trade in the over the counter market.
Uses
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Interest rate swap contracts are used by companies to hedge the interest rate risk inherent in its business. Others use the contracts simply to speculate on the future level of interest rates.
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Plain Vanilla Swap
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A plain vanilla swap involves one party paying a fixed rate of interest in return for receiving a floating or variable interest payment. The floating rate of payment is based on a spread to the London Inter Bank Offered Rate (LIBOR), the benchmark for the interest rate swap market.
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