What Is Interest Rate Swap?
Interest rate swaps are an agreement on the payment of cash flow in terms of a fixed interest rate as opposed to the floating and ever changing interest rate. This is a positive agreement between two parties, which are known as the counterparties. Interest rate swap helps the counterparties avoid the flux in interest rates which can be varied and undesirably liquid, and depends basically on the ever changing position of the market and currency value.
To put it in very simple terms, interest rate swap is basically exchanging one set of defined cash flows between two parties, for another set of liquid interest based cash flows. This system allows both counterparties to maintain a stable stream of cash flow, and to save much in case of changing interest rates, which tend to go up more often than not. Thus, expenses are reduced for both companies on every transaction made for a fixed period of time, to which both the counterparties have agreed in the terms and legal contracts.
Interest rate swap is a derivative which provides a company protection from the ever fluctuating interest rates in the market. Thus your company will benefit from a long term contract without having to factor in market uncertainties which are often caused by the flux in interest rates. A stable rate of payment and debt provides a stable and strong financial background for future transactions and long term planning. Acquiring business transaction deals at a lower interest rate also helps reduce costs and transactional expenses in both the long term as well as short term scenarios.
What Are The Different Types Of Interest Rate Swaps?
Interest rate swaps can be employed in all scenarios, those involving same currency transactions as well as those involving transactions among different currencies. Interest rate swaps can also be fixed for floating or floating for floating interest rates. Thus, the following permutations can combinations are noted:
– Fixed for floating rate swap for the same currency
– Fixed for floating rate swap for different currencies
– Fixed for fixed interest rate swaps for different currencies
– Floating for floating interest rate swaps for same currency
– Floating for floating interest rate swaps for different currencies
How And For What Can These Interest Rate Swaps Be Used?
Interest rate swaps are employed mainly in order to hedge one’s company against exchange interest rate controls and market fluctuations. Many new and interesting uses have been found where interest rate swaps are being utilized to make transactions more beneficial for both parties. These include some legal and barely legal applications. For example, hedge funds and investors use speculation and invest in swaps in order to reap the benefits of changing interest rates by liquidating after or inter term dealings.