From the course: Derivatives Fundamentals
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How interest rate swaps work
From the course: Derivatives Fundamentals
How interest rate swaps work
- [Narrator] The most widely traded swap contracts in the financial markets are plain vanilla interest rate swaps. An interest rate swap "swaps" a fixed rate of interest for a floating rate of interest. Two counterparties enter into an interest rate swap with one counterparty paying fixed, while the other counterparty pays floating. The amount of these payments will be calculated using fixed and floating interest rates and a notional amount, let's say a hundred million dollars, that is not swapped. Interest rates swaps are often done to take advantage of different comparative borrowing rate advantages of the two counterparties. Let's now add some numbers to the previous example to see how this works. Let's imagine company A and company B agree to swap fix for floating interest rates on a notional value of $1 million. Let's assume the term of the interest rate swap is two years with interest payments being swapped every six months. The fixed rate will be set at the start of the swap…
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