Interest Rate Swaps

QUOTE AND NEWS
The Economic Times  May 5  Comment 
In an electronically traded platform, investors maintain margins with the central counterparty, which will be much lower than the capital set aside for credit risk from OTC trades.
Mondo Visione  May 5  Comment 
TriOptima, the award-winning post trade infrastructure provider, announces that Eurex Clearing members completed the first successful triReduce compression cycle for cleared euro (EUR) interest rate swaps (IRS). This was the first collaboration...
Mondo Visione  Apr 18  Comment 
288 billion SEK in notional eliminated in Nasdaq Clearing’s first compression run for Interest Rate Swaps (IRS) In connection with the compression, backloading into Nasdaq Clearing (registering of historical trades to clearing) was commenced...
Mondo Visione  Mar 16  Comment 
Montréal Exchange (MX), Canada's leading derivatives exchange, today announced that it will expand its interest rate derivatives offering with the launch of Canadian Dollar Interest Rate Swap Futures based on the Eris MethodologyTM. These new...
Mondo Visione  Feb 22  Comment 
Trad-X, the market-leading platform for the trading of global interest rate derivatives, has announced a series of initiatives to boost liquidity and strengthen its presence in the global interest rate swap (IRS) market. Trad-X will launch a...
Euromoney  Feb 18  Comment 
Thanks to tighter capital requirements and a jump in corporate issuance, the relationship between US interest rate swaps and underlying treasuries is firmly in negative territory. Get used to it.
Mondo Visione  Nov 30  Comment 
BME Clearing, the Central Counterparty (CCP) of BME, today will start a new segment – BME Clearing Swaps – for clearing OTC interest rate swaps, having received authorisation for this activity in July. This new segment is launched in...
Reuters  Nov 26  Comment 
NEW YORK (IFR/Reuters) - A class action lawsuit, filed Wednesday, accuses 10 of Wall Street’s biggest banks and two trading platforms of conspiring to limit competition in the $320 trillion market for interest rate swaps.




 
TOP CONTRIBUTORS

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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