Interest rate swap

An interest rate swap can be described as a “bet” on a series of future changes in interest rates.

A typical interest rate swap is an agreement between two parties to “swap” (exchange) a fixed-rate interest payments for floating-rate interest payments. This means that an agreement is made that if an interest rate rises above the fixed rate, one of the parties will pay the difference between the fixed and the floating rate, while if it falls below the other party will pay the difference.

Swaps can be used for speculating as well as hedging. An investor is speculating if he or she does not actually have an underlying asset or a liability to hedge. His or her swap position is motivated solely by the prospect of a change in value in the swap as a result of changing interest rates. A speculator may take a fixed-rate payer position if he expects interest rates to rise or a floating-rate payer position if he expects rates to decline.