Interest Rate Swaps

QUOTE AND NEWS
Mondo Visione  Aug 18  Comment 
TriOptima, provider of OTC derivative post trade services, today announces that market participants have eliminated $500 trillion in notional principal outstanding since it introduced triReduce, its multilateral compression service, in...
Mondo Visione  Aug 1  Comment 
ICAP plc (IAP.L), a leading markets operator and provider of post trade risk mitigation and information services, announces today that July was another record month for ICAP’s i-Swap platform, the electronic arm of the ICAP SEF.  Record US...
Mondo Visione  Jul 23  Comment 
A team from the Computer Science Department of University College London (UCL), led by visiting professor Donald Lawrence, carried out an independent evaluation of the overnight process that maintains the Constant Maturity aspect of the GMEX...
DailyFinance  Jul 2  Comment 
ICAP’s award-winning interest rate swaps platform i-Swap, the electronic arm of the ICAP SEF, announces today another new monthly record for US Dollar interest rate swaps (USD IRS) volume in June 2014 of 588 trades (single...
Mondo Visione  Jun 4  Comment 
i-Swap, ICAP’s award-winning electronic interest rate swaps platform, which allows trading on the ICAP SEF, announces today that it has set a monthly US Dollar interest rate swaps (USD IRS) volume record in May of 428 trades worth a notional...
Banking Business Review  Jun 3  Comment 
Britain’s leading high street banks, including the Royal Bank of Scotland (RBS) and Barclays, have reportedly failed to meet the deadline for agreeing compensation to companies affected by the mis-selling of interest rate swap agreements.
BBC News  Jun 2  Comment 
Some leading High Street banks, including RBS and Barclays, miss a deadline for agreeing compensation to small businesses for mis-selling interest rate swaps.
Mondo Visione  May 16  Comment 
Singapore Exchange (SGX) has cleared more than USD 3 billion notional worth of Malaysian Ringgit (MYR) and Thai Baht (THB) Non-Deliverable Interest Rate Swaps (NDIRS) since its launch a month ago on 7 April 2014. This new asset class, with...
Times Online  May 7  Comment 
For those thrilled by the Libor and interest rate swap scandals — you’re just going to love the foreign exchange...
Mondo Visione  Apr 8  Comment 
Singapore Exchange (SGX) is pleased to launch the clearing of Non-Deliverable Interest Rate Swaps (NDIRS) in Malaysian Ringgit and Thai Baht on 7 April 2014. This new asset class, which will be settled in US dollars, further augments SGX’s...




 
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The chart on the left is the 3 month interest rate swap.

Interest rate swaps are a common type of derivative security, which simply means that their value is “derived” from underlying assets (in this case, loans and interest rates). In a swap, two parties agree to exchange two streams of cash flow; in an interest rate swap, these cash flows are the interest payments for some given amount of money. The underlying money, known in this context as the notional amount, doesn't necessarily change hands. The two parties just exchange the interest payments they would make if they had actually borrowed the notional amount.

There are three main types of interest rate swaps, as determined by the type of rates being swapped:

  • Fixed-for-fixed swaps involve the exchange of interest payments that both carry fixed rates determined before the contract takes effect. Since there's no variability in either of the two rates, the payments will remain the same over the life of the swap contract. Fixed-for-fixed swaps are used when each party uses a different currency.
    • For example, suppose there are two companies in different countries, each of which wants to borrow money to build facilities in the other country, and that both can borrow at a lower interest rate in their home country. In this case, the companies can borrow money in their respective countries and swap with each other, essentially borrowing for each other. Each saves money by taking advantage of the other firm's lower cost of borrowing while also dodging currency conversion costs.
  • Fixed-for-floating, or "vanilla" swaps, commonly used as a type of investment, involve the exchange of a fixed interest payment for a floating interest payment. The payment with the fixed rate (known as the swap rate) doesn't change, while the payment with the floating rate is linked to some outside index (such as the LIBOR) and rises and falls throughout the duration of the contract.
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    • This type of swap can be used if a company wants to trade the floating rate on its debt for the stability of a fixed rate. In the example, Firm A has a floating rate loan but pays a fixed rate to Firm B. Firm B receives a fixed payment from Firm A and pays it a variable payment in return, which Firm A then pays to its lender. In this case, Firm A thinks that interest rates will rise and hopes to avoid higher payments by trading for a fixed rate. Firm B, on the other hand, probably thinks that rates will fall; if it's right, it will pay out less than the fixed amount it receives from Firm A, making a profit off the difference.
  • Floating-for-floating, or "Basis" swaps, as the name implies, involve the trade of interest payments that both have floating rates. The rates are based on different indexes, so each party is betting that either their original rate will rise, the other party's original rate will fall, or some combination of the two.

Interest rate swaps are traded over the counter (OTC), most commonly on fixed income desks at investment banks. Because they are not traded on open exchanges, interest rate swaps are not regulated by any government agency, so parties have a great deal of flexibility when setting the terms of the swap. Globally, the total notional amount of interest rate swaps outstanding was $309.6 trillion USD as of December 2007, accounting for 52% of the total OTC market.[1]

Interest Rate Swaps on Wikinvest

References

  1. Semiannual OTC derivatives statistics at end-December 2007 - Bank for International Settlements
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