This paper provides a concise introduction to interest rate swaps as over-the-counter financial contracts between two parties. It explains the mechanics of fixed-for-floating rate swaps, defines key roles such as payer and receiver, and identifies reference rates including LIBOR and EURIBOR. The paper also outlines the primary motivations for entering swap agreements — hedging against interest rate movements, speculative positioning, and arbitrage — and briefly describes how each party's borrowing exposure changes as a result of the swap.
An interest rate swap is an over-the-counter (OTC) contract traded between two parties, whereby both parties agree to exchange future interest payments based on a specified principal amount. This exchange typically involves one party paying a fixed interest rate while receiving a floating interest rate from the other party — making the fixed-for-floating swap the most common form of this instrument. However, all other combinations are also present in such agreements, including floating-for-floating swaps, fixed-for-fixed swaps, and floating-for-floating swaps involving different currencies.
One of the most common forms of interest rate swap is the fixed-for-floating rate swap. In this arrangement, one party pays its fixed interest rate to the other party and, in exchange, receives a floating rate from that party. The floating rate is typically calculated around a reference rate such as LIBOR or EURIBOR — for example, LIBOR + 1%. The party that pays the fixed rate and receives the floating rate is called the payer, while the party that receives the fixed rate and pays the floating rate is called the receiver.
"How swaps change each party's borrowing position"
"Hedging, speculation, and arbitrage use cases"
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