Interest rate swap market. Swap: what is it, interest rate, currency, default, overnight swap

Hello, friends. They sent me on a business trip last week.

We had to conduct training for two days for employees of one of our branches.

Most of the time was spent talking about SWAP - what it is and what its main features are. It’s good that the employees grasped everything on the fly and didn’t ask unnecessary questions.

A lot of useful material has accumulated, so now, dear readers, I will conduct a detailed analysis of this topic for you. So, let's start without rocking.

We explain the concept of “swap” in simple words

Everyone knows that a swap is a commission for the right to transfer a transaction to the next day. But this word is a more comprehensive financial concept than what traders use in their vocabulary.

Let's look at swap - what it is in simple words and, at the same time, in scientific language.

From a scientific point of view

Swap - English - is an agreement that allows assets or liabilities to be temporarily exchanged for other obligations (assets). This right is usually used to improve the structure of liabilities and assets, as well as reduce risks.

The structure of the agreement is two parts. In its first part, the primary exchange is carried out. In the second part, closure is performed (the so-called reverse exchange).

What types are there:

Currency swap is a currency swap.
En:stock swap - promotional.
Precious metals.
En: interest rate swap - percentage.

Foreign exchange. With a currency swap, two transactions of buying and selling a certain amount of currency are carried out, with different value dates.

That is, such a swap has two dates when currencies are exchanged. This is the most common market instrument, which occupies a significant percentage of the total turnover.

It is used for speculation with differentiated interest rates, for managing the cash flows of the dealing room, for servicing internal and external clients, and for arbitrage operations to make a profit on price differences.

Swap on shares. This is an exchange of payment streams based on the total return, taking into account some stock index and some interest rate with a constant or variable component.

That is, there are two features - features of shares (securities) and at the same time interest payments (fixed or floating).

Such a product expands investment opportunities when pouring into stock markets in developing countries, which includes Russia.

Precious metal swap. A transaction in which a purchase/sale of a precious metal occurs and at the same time a reverse transaction (purchase/sale) is carried out.

It should be noted that such transactions do not have such a strong impact on the precious metals market, such as spot transactions.

Percentage. What is an interest rate swap in simple terms? So, two parties enter into an agreement to exchange cash flows denominated in the same currency, but with different bases.

That is, an exchange of interest rates is carried out when an interest rate with a fixed value is exchanged for a floating one or in the opposite direction.

The parties to the agreement, having received borrowed funds, want to improve the conditions for themselves, and therefore enter into an interest rate swap. Moreover, the parties may have different goals. Someone, by changing the rate, hedges the risk of changes in loan rates.

And someone wants to attract funds using a fixed rate, and then a floating one.

Borrowers of funds exchange interest payment terms directly among themselves by transferring the interest difference to each other.

So swap, what is it in simple words - exchanging something for time. For example, you are going to the USA, and I am going to the UK. You have euros, I have dollars.

Together we decided to exchange this money, just in case there wasn’t enough there. You give me euros, and I give you dollars. Upon your return, we will make a return exchange.

In general, nothing like that happened, but the risk that each of us would not have enough money was much reduced.

Why know this if you are not a participant in the Forex or stock market? Well, at least for erudition and to roughly understand what the smart guys are talking about. Traders should not confuse this concept with the column indicating the swap for transactions.

Source: http://site/fx-binar.ru/chto-takoe-svop-prostymi-slovami/

What is Swap on the Forex exchange?

The concept swap has two meanings. Let's look at them in more detail separately. On the Forex market, the term currency swap is often used.

Currency swap is a combination that is based on two transactions that are opposite in direction, but have the same currency and the same volume. The value dates for this transaction are also different.

Such transactions can be concluded for quite long periods (up to 1 year). Longer periods actually do not lend themselves to any forecasts, and this greatly complicates the calculation of the financial result from such transactions.

Swap on the Forex exchange is divided into 2 types depending on the queue of the operation. Buy-swap - this option implies that the currency will be purchased first, and then sold.

In the second case, a Sell swap is used - the first operation to sell a currency occurs, then the transaction is closed by buying it.

The size of the commission depends on the type of transaction being carried out; this parameter is not constant. This aspect should also not be forgotten. In addition, the swap can be designed and clean.

With the pure option, the operation is performed with one counterparty. If an additional participant is involved in its implementation, then the swap will be of a designed nature.

Depending on the time, swaps are divided into the following groups:

On forward terms - the settlement date for the first transaction is realized under forward terms, for the last one - under spot conditions.
Intraday – no commission is charged for transferring a position, the operation is closed in one business day.
Standard – the distant settlement date is carried out according to forward conditions, and the nearest one – according to spot conditions.

When concluding transactions, calculating the cost of swap plays an important role. In this case, the following indicators are taken into account: the current exchange rate and interest rates.

Typically, brokerage companies record the swap value for each currency pair, so a trader can find out the cost of transferring a position without preliminary calculations.

Also, the commission charged may have different signs (positive/negative). If the swap is positive, the trader is credited with a certain percentage.

Source: http://site/workon.ru/chto-takoe-swap-na-birzhe-forex/

Transactions on the Forex market are concluded on spot terms. This means that all trades entered into on the current business day must be delivered in full of the base currency on the second business day.

In the case of margin trading, there is no actual delivery and in order to avoid delivery, it is necessary to make a SWAP type trade, i.e. close a position at the current rate on the previous value date and re-open it at the current rate, taking into account SWAP points on the next value date.

The SWAP operation (in this case SWAP tom/next) is a standard banking operation and allows you to move the date of actual currency delivery one day ahead.

This operation is performed for all remaining open positions at 23:59 system time (GMT+2).

After performing the SWAP operation on the Trading tab of the terminal, you will see that your yesterday's positions are closed and reopened. The closing and opening rates differ by some amount - SWAP points.

Attention!

The number of these SWAP points is calculated depending on the discount rates for each currency, and can be either positive or negative.

After the SWAP operation, only the amount of the result remains unresolved between the parties, i.e. profit or loss recorded on your account as a result of the SWAP operation.

At the same time, you need to understand that SWAP itself has almost no effect on the final result of your transaction, with the exception of SWAP points

Let's look at the picture:

Level A is the moment of opening a position at price 1
Level B is the moment of transferring the position to the next day, closing and opening at price 2
Level C is the moment of closing a position at price 3

It is easy to see that the difference between the prices of A and C (the profit and loss you receive) is the same as the sum of the difference between the prices of A and B and the prices of B and C,

That is (C – A) = (B – A) + (C – B)

How SWAP points are calculated

For the currency of each country, its Central Bank sets the discount rate. Different countries have different rates, and the difference can be very significant (for example, the discount rate on USD is twice the discount rate on EUR).

When, for example, you make a transaction to sell EUR for USD, you are actually giving away a currency (EUR) with a lower interest rate, and in return you receive another currency (USD) with a higher one.

The minimum term of a bank loan is one day, and even for such a short period, banks charge interest on the amounts used in your work.

In this example, when you sold EUR for USD, the bank will pay you extra for every day while you are in this position. And vice versa, if you buy EUR for USD, you will pay extra to the bank for each transfer of the position to the next day.

For example, there is a long position (buy) in EUR at 1.4390. It does not close on the same day; at 23:59 a sell/buy swap is performed in the system at the current Bid price in the System, taking into account SWAP points. Now SWAP points for euro = -0.13/-0.02

SWAP for positions remaining from Wednesday to Thursday is a long SWAP, because the value date of a new opened position is Monday and SWAP points are taken 3 days in advance.

Source: http://site/forex.ukrgasbank.com/rus/metatrader/swap/

Overnight swap (Payment for an open trade)

A currency swap implies a fee for moving a position overnight, that is, this is a kind of penalty for the fact that the trader did not close the transaction on the day it was opened. Swap can be either positive or negative.

A positive swap is charged to the client if he purchased the national currency of a country with a higher bank discount rate, and is charged to the client if he purchased the currency of a country with a lower discount rate.

The swap is independent of margin requirements and account sizes.

When trading, it is worth considering that the swap is charged for each day of holding the position in equal amounts, but from Wednesday to Thursday a triple swap is charged, since the date of the swap operation from Wednesday to Thursday is considered to be Friday and Monday.

Currency swaps, depending on the timing of their implementation, are divided into three types:

forward - they are characterized by combinations of transactions, when the closest transaction is concluded on the condition that the value date is later than the swap, and the reverse one is concluded on the terms of a late forward.
standard - they are characterized by the closest value date - spot, and the farthest - forward.
short or overnight swaps.

To better understand what a swap is, let's consider an example with a currency pair, but for ease of calculation, let's change the interest rates of countries. The trader opened a trading position to sell one lot on the EUR/USD currency pair.

The trader sells 100 thousand euros, having previously borrowed them at 4% per annum. In exchange, the stock speculator bought US dollars and deposited them in a bank deposit at 3% per annum. Transaction costs are 1% (4% - 3%).

1% taken from 100 thousand euros is 1250 US dollars. If you divide this amount by 365 days, you get approximately $3.4 per day. This is a swap.

To determine whether it is positive or negative, you need to compare the interest rates of the two countries. In the example under consideration, the deposit rate is 3%, and the credit rate is 4%.

That is, the trader’s loan does not cover his deposit. Thus, if he sells euros, then every day a swap of 3.4 US dollars will be debited from his trading account.

If the trader decides to purchase euros, then his deposit rate will exceed the credit rate, therefore, this amount will be credited to his trading account.

Source: http://site/www.teletrade.com.ua/novice/glossary/svop-overnight

Interest rate swap

An interest rate swap is an over-the-counter transaction in which two parties exchange interest payments on loan obligations of equal amounts, but with different interest rates.

Interest rate swaps are typically long-term instruments whose purpose is similar to that of an agreement on a future interest rate, but the duration for major currencies ranges from 2 to 10 years.

Attention!

An interest rate swap is an agreement between parties to make a series of payments to each other on agreed dates before the expiration of the agreement.

The amount of interest payments by each party is calculated based on different formulas, based on the notional principal amount of the agreement.

A typical transaction of this type involves exchanging the interest payment on a fixed-rate instrument, such as a coupon bond, for a floating-rate interest payment.

Interest rate swaps are traded over the counter and are one of the most widely used money market instruments in the world.

The simplest instruments include a fixed/floating rate swap, in which one of the counterparties makes payments at a fixed interest rate, and the other at a floating rate linked to a reference rate, such as LIBOR.

Since an interest rate swap does not involve delivery of principal, interest accrues on the notional amount.

An interest rate swap is an instrument of two counterparties borrowing the same amount at interest rates on different bases and then exchanging interest payments.

Since there is no exchange of principal, credit risk is limited to the interest payments received from the counterparty.

Most often, only the difference between the gross interest payments of counterparties is paid in settlements, so credit risk is limited to the net cash flow.

The point of interest rate swaps is that they allow borrowers to decouple the basis on which they pay interest from the underlying money market instrument used to actually borrow.

Thus, a borrower who wants to pay a fixed annual interest rate on a loan with a maturity of one year, but can only obtain financing in the form of short-term 3-month commercial paper, can use an interest rate swap that allows him to receive 3-month LIBOR and pay an annual fixed rate.

Each time the 3-month commercial paper is redeemed, it is simply renewed.

Thus, on a loan, the borrower pays 3-month LIBOR, and on a swap, the borrower receives payment on 3-month LIBOR in exchange for paying an annual fixed interest rate. As a result of this exchange, his net payment represents an annual fixed interest.

This fixed/floating rate swap is called a plain vanilla interest rate swap.

There are also floating/floating rate swaps, which are also called basis swaps or diff swaps.

Conditions and characteristics

Items that require approval when entering into an interest rate swap agreement include the following:

Effective date. The date on which interest begins to accrue on both sides of the swap.

Date of completion. The contract or maturity date for which the final interest payment is calculated.

Notional amount. The amount used to calculate the interest payments of both parties.

Payer/receiver of a fixed rate. Since in most swaps payments are made by both parties, one at a fixed rate and the other at a floating rate, referring to the counterparties as “buyer” and “seller” can be misleading.

In this regard, one of the counterparties is usually called the fixed rate payer, and the other - the fixed rate recipient.

The basis for calculating the interest rate. Includes all elements necessary to calculate interest payments, including:

a benchmark interest rate, such as LIBOR;
payment periods and dates;
number of days in a year for calculation.

Transactions with interest rate swaps on the market

Interest rate swaps are one of the most actively traded derivative instruments and a critical element of the world's capital markets.

The previous example showed how an interest rate swap allows a borrower to pay a fixed annual rate even when he only has 3-month money market instruments.

Attention!

It is the access to various markets, coupled with the high liquidity of the swaps market, that makes the IRS such an attractive tool for borrowers.

The advantage of interest rate swaps is that they allow borrowers to hedge the interest rate they must pay on borrowings over a specified period in the future.

While a future interest rate agreement allows you to lock in the interest rate for a period of at least 3 months starting three months from now, an interest rate swap extends that period to 30 years from today.

This opens up the possibility for borrowers who are unable to access the long-term debt market, for example due to an insufficient credit rating, to raise funds in the short-term money market and pay long-term interest rates as a result of the exchange.

Borrowers thus gain greater certainty when financing long-term projects and the chance to pursue projects that would otherwise be too risky due to possible rising interest rates.

Note. In the first section, we looked at how governments and central banks use interest rates to dampen or stimulate economic activity.

So, business projects that are financed at a fixed interest rate through interest rate swaps are immune to rising interest rates.

Of course, there is always a downside - exchanging borrowing rates for long-term fixed ones does not allow you to benefit from lower interest rates.

Note that interest rate swaps are not only used by borrowers. Speculators also find them attractive instruments because they allow leverage in the absence of principal exchange.

Grade

An interest rate swap in the initial period of its validity has no value for any of the counterparties.

This is because the fixed rate side of the swap is priced as an average interest rate that, over time, becomes equal to the expected future value of the floating rate payments.

The present value of the floating rate payments is calculated based on the forward rates of each payment period over the life of the swap and then discounting each payment.

An interest rate swap produces gains or losses for counterparties only if interest rates differ from forward rates.

In other words, the counterparty can receive a profit from the IRS only if the future situation does not match the forecast of the forward markets.

If, during the life of the contract, interest rates rise or fall as predicted by the forward market, neither counterparty will make a profit or loss.

Yield curves for swaps

We have already looked at the yield curve, which is a graph of interest rates versus maturity, for money market and debt market instruments.

The same curve in “interest rate - term” coordinates can be constructed for swaps.

A swap yield curve is a graphical representation of the relationship between fixed rates on interest rate swaps and their term.

For valuation purposes, an interest rate swap can be thought of as a series of coupon payments on an imaginary synthetic fixed-rate note on the fixed-rate side versus a series of interest payments on an imaginary synthetic floating-rate note (FRN) on the floating-rate side.

The swap yield curve can be thought of as the yield curve of a synthetic fixed rate bond.

The approach of pricing a swap based on the difference between the value of a straight bond and the value of a floating rate instrument allows market makers to hedge or “warehouse” a swap position by temporarily buying or selling the underlying bond.

The fixed rate payer buys the underlying instrument, which it can then sell to offset the position if swap rates fall.

The recipient of the fixed rate sells the underlying instrument to offset losses if swap rates rise.

The calculations here are quite complex and time consuming. In practice, traders often use charts to evaluate the swap relative to the instruments with that maturity selected as a reference.

A similar graph is, in particular, the spot curve, or the zero coupon yield curve.

Attention!

The yield to maturity (YTM) curve for bonds is simply a graph of YTM values versus term. Unfortunately, this approach oversimplifies the situation, so it would be more correct to use a graph of spot rates versus maturity.

The spot rate is a measure of the YTM of a financial instrument at any point in time that takes into account various market factors.

The spot rate-term graph is called the spot rate curve or zero coupon yield curve because the spot rate on an instrument is equivalent to the yield on a non-coupon instrument, that is, a zero coupon instrument.

This means that the spot rates of a series of zero coupon instruments with different maturities can be directly compared.

The curves reflect the relationship between the yield of an instrument and its duration, usually measured in years. Depending on the shape, the curve can be:

positive;
negative (reverse).

Positive yield curve. In this case, short-term interest rates are lower than long-term interest rates. This is the situation that occurs most often: the longer the investment period, the higher the income paid.

In anticipation of an increase in interest rates, investors begin to invest assets in long-term instruments, which causes a decrease in short-term rates and an increase in long-term ones.

Negative or inverted yield curve. When short-term rates fall, investors move their investments into long-term financial instruments to earn higher returns.

An increase in the supply of long-term financial resources causes a decrease in long-term rates.

Yield curves help you identify the differences between financial instruments with similar credit characteristics, such as an interest rate swap and a Treasury bond with the same terms. How do you use a spot rate curve to value a swap?

For greater precision, imagine an interest rate swap as sequential fixed rate cash flows on the one hand, combined with sequential floating rate notional cash flows on the other hand, which can be thought of as a strip of FRA or futures contracts.

The rates determined by the curve allow you to calculate in advance the amount of the net payment for each future payment date.

The swap rate is effectively equal to the average FRA strip rate or futures contract.

Source: http://site/fx-fin.net/instr_denr/proc_sv.html

What are swap points

A swap occurs when a transaction is postponed to the next day. Swap (Rolover or Overnight) is the opening of two opposite transactions that have different value dates. The rate of these transactions is calculated at the time of their completion.

The first trade ends the current trade, and the second trade opens a new one. The need for this operation arises when transferring a transaction overnight.

For example, if a participant opened a EUR/USD transaction during the daytime, then after the end of the calendar day, the same transaction is opened again at the beginning of a new day.

A swap can be either profitable or unprofitable for the trader. This will depend on the interest rate differential between the currencies involved in the pair and also (to a lesser extent) the brokerage company you deal with.

Typically, you can find out the current values of crediting/writing off the swap amount on your broker's website.

From Wednesday to Thursday, the triple swap is credited/written off.

The fact is that the calculation of the swap for a deal opened on Wednesday is made on Friday, and, therefore, the swap rate of the transferred rate will be calculated on the next business day, i.e. on Monday. That is why the swap is observed in 3 days.

Source: http://site/xdirect.ua/study/faq-novichka/chto-takoe-svop-punkty

Credit default swap

Credit default swap is one of four types of swap. The other three are simple interest rate swap, index swap, and currency swap.

In English, credit default swap. Abbreviated as CDS, in Russian – KDS. Another possible full name of the CDS in Russian is credit default swap.

A credit default swap is a contract between two parties. The first party is exposed to the risk of non-repayment of the loan, it has a demand for risk protection and is called the buyer of protection.

The second party offers such protection and is called the seller of protection.

Attention!

Credit default swap is an American invention. The first signs of its discovery in life date back to the early 90s of the last century. However, the actual birth of these contracts is 2003. This year their market begins to develop rapidly.

After 3 years, their value becomes equal to the volume of world GDP. After 4 years, $62 trillion in contracts have been signed.

This means that there are more credit default swaps than goods and services produced in the world in 2007 by 1.3 times.

One of the reasons for the boom in such swaps is their location outside of exchange trading. Transactions on them were also not submitted to regulatory authorities.

Acting as a semblance of credit insurance and hedging, in this capacity, however, they also did not fall under the appropriate regulation.

Another reason for the boom was the development of naked credit default swaps, tied to the debt obligations of “reference” entities, which allowed traders to speculate on the issue of debt obligations.

This boom, in turn, became one of the causes of the global financial and economic crisis of 2008-2010. During the first year of the crisis, the volume of credit default swaps fell to $38 trillion, that is, 1.8 times.

Source: http://site/dictionary-economics.ru/word/Credit-default-swap

Forex currency swap: essence, features, varieties

The process of currency investment on Forex is necessarily associated with such a concept as swap. What is swap?

Traditionally, from economics, this indicator reflects a combination of two transactions for the exchange of foreign exchange assets of different directions (purchase and sale). Moreover, each exchange transaction has its own execution date.

In the application to Forex, swap means a positive or negative balance on a transaction (specifically in terms of exchange), caused by the difference in rates on the date of the previous and current trading day.

One way or another, some of them will be associated with independent income or expenses on contracts that have been active for more than a day - this is reflected in the “swap” column.

The essence

Currency swap is especially relevant for those traders who work in the medium or long term. This is explained by the fact that intraday transactions do not involve expenses and income of this type.

The essence of this difference is associated with changes in the commercial exchange rate characteristic of a particular date.

It is clear that if the exchange rate of the selected pair is constantly changing either up or down, then the overall swap remains unstable.

Peculiarities

Since a swap transaction is a multidirectional currency exchange operation, it is characterized by certain features. Their study allows us to better understand the mechanism of creating exchange differences.

Secondly, the recalculation of financial indicators for the transaction occurs during weekdays at 21:00 GMT, regardless of when the transaction was opened.

In fact, it turns out that brokers close all active positions every day from Monday to Friday at 21:00 and open them again using the new currency exchange rate.

Thirdly, the swap value is determined not only by the exchange rate, but also by the commission of the broker (dealing center) for transferring the position within 24 hours.

So, for example, if a trader purchases a currency with an increased discount rate of a world bank, then the difference is reflected in his account in the form of a positive balance. But this difference is reduced by the amount of the intermediary organization’s commission.

Fourthly, the size of the swap difference depends on the volume of the transaction. Since the exchange rate and discount rate for a particular currency are calculated for each unit of funds, the amount of capital involved in a separate contract directly affects the size of the swap difference.

Positive and negative

There are two types of swap:

positive difference;
negative difference.

Above, we superficially paid attention to how a positive balance is formed. But let's look in more detail at both varieties.

The formation of a swap is affected by the interest rate differential. Otherwise, it is called the difference in the interest rate of national banks (derived by analyzing the exchange rates of leading national banks that are directly related to the currencies in question included in the pair).

The amount of the swap is also influenced by the size of the dealing center’s commission. Moreover, according to the principle of the impact of the interest differential, the difference can be either positive or negative, but according to the principle of calculating the brokerage commission, it can only be negative.

A positive swap is formed if before 21:00 GMT the World Bank discount rate for the exchange of the currencies in question included in the pair was lower than after the specified time.

This difference is slightly reduced by deducting commission income for the dealing center for moving the position through the trading day.

A negative swap is formed if, before 21:00 GMT, the World Bank discount rate for the exchange of the foreign exchange assets in question was higher than after the specified time.

This difference is increased by deducting (and in this case, accruing) the dealing center’s commission for transferring a position through a trading day.

Example

To further understand the intricacies of this difference that occurs on Forex, let’s consider a practical example of swap calculation.

Let's assume we are working on the Pound/Dollar pair. The interest rate in the UK is 6%, and in the US - 3%. We will accept the exchange rate at 1.9800.

In this case, let’s assume that a purchase or sale transaction is concluded in a volume of 1 lot (100,000 units of the currency that serves as the base).

The difference in the form of swap will be calculated as follows: (((6% - 3%) * 1 * 100,000 * 1.9800) / 100%) = $5940/year. Distributing this amount evenly over the number of days in a year, we get a swap per day: 5940/365 (366) = $16.27/day.

It is important to understand the basic operating principle of such an exchange mechanism. If a purchase contract is opened for the Pound/Dollar pair, then 100,000 US dollars are actually lent (in this case, borrowed) at 3% per annum and 1.98 times less pounds sterling is placed on deposit at 6% per annum.

If a sell contract is opened for the Pound/Dollar pair, then the opposite operation occurs.

In this case, pounds sterling is borrowed at 6% per annum, and US dollars are deposited at 3% per annum.

In these situations, an inverse relationship is observed: in the first case, the deposit rate is higher than the credit rate, and in the second case, the credit rate exceeds the deposit rate.

Therefore, when opening a purchase transaction, a positive swap is formed, and when selling, a negative one. Based on our example, a long position would result in a credit of $16.27 to the account, and a short position would result in a debit of this amount.

However, it should be taken into account that Forex has a “spot” system. According to its terms, payments are made within the second working day. Taking into account the inactivity of the market on Saturday and Sunday, if the transaction is postponed to Thursday, the swap will be charged for three days.

Attention!

So, a currency swap is a mandatory commission that is paid by every trader on the market. It is determined by the interaction of two indicators: the amount of remuneration of the dealing center for transferring a position through trading days and the interest differential of national banks.

A swap can be either positive or negative - it depends on the discount rate in national banks for the currencies included in the pair.

The mechanism for calculating a currency swap is very simple: if the deposit indicator is higher than the credit indicator, then a positive difference is formed, and if, on the contrary, a negative difference is formed.

Using pairs with the maximum difference in rates, you can manipulate the type of currency swap. Among the pairs most suitable for this are the Australian Dollar/Japanese Yen and the New Zealand Dollar/Japanese Yen.

Interest rate swap - English Interest Rate Swap, a contract between two parties to exchange interest payments that are for a pre-agreed and specified amount in the contract, called the contract amount. That is, on a predetermined date (or dates if the swap involves the exchange of payments at specified intervals during the contract period), one party will pay the other a payment calculated on the basis of a fixed interest rate, and in return will receive a payment calculated on the basis of a floating interest rate (for example , at the LIBOR rate). In practice, such payments are netted and one of the parties pays only the difference of the above payments.

The advantages of interest rate swaps include the fact that they make it possible to reduce the cost of attracting and servicing a loan. For example, a borrower who has the opportunity to obtain a loan at a fixed interest rate wants to take out a loan with interest accrued at a floating rate, but is not able to obtain such a loan on favorable terms. At the same time, there is another borrower who has the advantage of obtaining a loan on which interest is calculated on the basis of a floating rate, but he wants to receive a loan at a fixed interest rate. In this case, the parties can enter into an interest rate swap, which involves the exchange of payments that are calculated based on fixed and floating interest rates on the loan amount. As a rule, the parties do not exchange the principal amounts of the contract, but transfer only payments calculated based on the difference in contract interest rates.

Let's look at an interest rate swap as an example.

The first counterparty to the swap (company) can take out a loan in the amount of 10 million USD with a repayment period of 3 years with a fixed rate of 12% or with a variable rate equal to LIBOR + 1%.

The bank can obtain credit resources on the interbank market in the same amount and for the same period with a variable interest rate equal to LIBOR or a fixed rate of 10%.

In this case, the difference between fixed interest rates is 1% greater than the difference between variable rates.

To conclude a swap, the company takes out a loan with an interest rate equal to LIBOR + 1%, and the bank - with an interest rate of 10%.

After concluding a swap, the bank periodically pays the company a floating interest - LIBOR, and the company periodically pays the bank a fixed interest - 10.5% (0.5% is a bonus to the bank, 10% is a fixed percentage of the bank for loans taken for the company). Thanks to the swap, the company reduces the financing costs of a loan with a fixed interest rate by 0.5%, and the bank also saves on the costs of financing debt with a variable interest rate of 0.5%.

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✪ Interest rate swap 1

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✪ Currency swap (swap)

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✪ What is swap swap on Forex? Forex currency swaps

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Let's say there is a company A and it borrows an amount of $1 million and pays interest on this loan at a variable rate. She pays LIBOR plus 2%. LIBOR is the London Interbank Offered Rate. This is one of the main benchmarks for variable interest rates. The company pays it to some creditor. This is the person who lent money to Company A. She pays him at a variable interest rate at regular intervals. For example, in the first period, if LIBOR is 5%, then during this period company A will pay the lender 7%, that is, $70,000. In the second period, if LIBOR decreases slightly - to 4%, company A will pay (4 + 2), which is equal to 6%, that is, $60,000. Let's say there is another company. Company B. It also borrows $1 million at a fixed rate. Let her borrow them at a fixed rate of 8%. That is, in each period - no matter what happens with LIBOR or any other criterion - it is possible that she borrows money from the same lender that A borrowed from. This could be a bank or another company, or some investor. We'll call them Lender 1 and Lender 2. Regardless of the period, right now Company B will pay 8% of the $1 million for each period, which is equal to $80,000, which is exactly $80,000 for each period. Now let's imagine that neither of these parties is happy with this situation. Company A doesn't like the volatility, the unpredictability of what will happen to LIBOR, because it can't plan its payouts. Company B feels like it is overpaying in interest. It seems to her that those who pay a variable interest rate pay less interest each period. Maybe company B also thinks that interest rates will decrease, that is, that in the near future the variable rate will decrease, LIBOR will decrease. This is the main reason why B wants to get a loan with an adjustable rate. What should they do? Neither company can get out of these debt agreements, but they can agree to essentially swap some or all of the interest payments. For example, they might enter into an agreement called an "interest rate swap" where company A agrees to pay B - let's say 7% interest on a notional $1 million. That is, 1 million does not change hands, but company A agrees to pay B 7% of this notional $1 million or $70,000 for each period. In exchange, Company B agrees to pay A a variable percentage. Let's say it's LIBOR plus 1%, right here. This is the agreement. They agreed on such terms for a certain amount of money. This would be equal to LIBOR plus 1% on an imaginary $1 million. The word “imaginary” means that this $1 million will not change hands, the companies will only exchange interest payments on this $1 million. And this agreement is called an interest rate swap. We'll stop there. In the next video we will go through the whole mechanism and we will see that A is now actually paying a fixed rate and all their payments are included in both the swap and the lender, and company B, having entered into this agreement, will pay a variable interest rate. Subtitles by the Amara.org community

Structure

In an IRS transaction, each counterparty agrees to pay a fixed or floating rate, denominated in one currency or another, to the other counterparty. Fixed or floating rate multiplied by notional principal amount(say $1 million). Sharing this notional amount between counterparties, as a rule, is not carried out; it is used only to calculate the amount of interest cash flows to be exchanged.

The most generally accepted by the IRS is a transaction in which one counterparty (the counterparty A) pays a fixed rate (swap transaction rate) in favor of the counterparty B, receiving in return a floating rate (usually linked to a base rate, such as LIBOR or MOSPRIME).

A pays a fixed rate in favor B (A receives a floating rate)
B pays a floating rate to A (B receives a fixed rate).

Consider an IRS transaction in which a party A, having a loan (to a third party) at a floating rate of LIBOR+150 (=+1.50%), undertakes to pay in favor of the party B fixed periodic interest payments at a rate of 8.65% ( swap rate) in exchange for periodic interest payments at the rate of LIBOR+70 basis points (“ bp", =+0.70%). That is A has a “sum” from which it receives a fixed income for swap rate, but would like to have income at a floating rate, that is, the same as the loan obligations: LIBOR+. She turns to IN for the purpose of concluding an interest rate swap - a transaction in which A will receive income from the “amount” at the LIBOR+ rate instead of a fixed rate ( swap rate), A IN will receive income from its amount at a fixed rate instead of the floating LIBOR+. Benefit for A is that the swap eliminates the discrepancy between the income from the "amount" and the expense of the loan - they are now both tied to the LIBOR rate.

It is worth paying attention to the fact that:

there is no exchange of principal between the parties and that
interest rates apply to the “notional” (i.e., imaginary) principal amount.
interest payments are not paid in full, but are offset between the parties, after which the balance of the offset is paid.

(L I B O R + 1, 50%) + 8, 65% − (L I B O R + 0, 70%) = 9, 45% (\displaystyle (LIBOR+1.50\%)+8.65\%-(LIBOR+0 .70\%)=9.45\%),net.

The fixed rate (8.65% in this example) is called swap rate.

Drawing: A receives a fixed income of 8.65% and pays LIBOR+1.50%. A wants to convert both flows to LIBOR+. A enters into a swap with IN- “redirects him an income of 8.65%” (in reality, not all of it, but only the “netting” balance - the difference between 8.65% and LIBOR + 0.70%) and “receives income LIBOR + 0.70%.” Since the return on the asset is not explicitly shown in the figure, it can be misleading.

At the time of the transaction, the pricing of the swap is such that the swap has a zero current net value ( N P V = 0 (\displaystyle NPV=0)). If one party is willing to pay 50 bps over the swap rate, the other party must pay about 50 bps over LIBOR to compensate.

Types

As an over-the-counter instrument, IRS transactions can be entered into on a variety of terms to meet the specific needs of the parties to the transaction.

The most common exchange transactions are:

The parties to the transaction may be in the same currency or in two different currencies. (Transactions f i x e d − f o r − f i x e d (\displaystyle fixed-for-fixed) in one currency are generally not possible since the entire flow can be predicted from the outset of the transaction and there is no point for the parties to enter into an IRS contract since they can settle immediately for known future interest payments).

Fixed-For-Floating, one currency

Side IN

A And
A, indexed by the curve X for a notional amount N for a period of T years.

(in reality, a transfer is made from A to B (or vice versa - depending on whose payment is greater) by the amount of the balance (netting) - the difference in “payments”)

For example, you pay a fixed rate of 5.32% monthly in exchange for Libor USD 1M also monthly for notional amount$1 million over 3 years.

The party that pays a fixed rate in exchange for a variable rate has a long IRS position. Interest rate swaps are essentially a simple exchange of one set of interest payments for another.

Single currency swaps are used for exchange

assets/liabilities with a fixed rate on
floating rate assets/liabilities and vice versa.

For example, if a company has

investment in the amount of 10 million USD with a yield of 1M USD Libor + 25 bp with monthly fixing and payments

she can contract with the IRS

According to it it will be:

pay a floating rate USD 1M Libor+25 bp
receive a fixed rate of 5.5%,
thereby recording an income of 20 bp.

Fixed-For-Floating, 2 currencies

Side P

pays (receives) a fixed rate in foreign currency A And
receives (pays) a floating rate in foreign currency B, indexed by the curve X for a notional amount N for a period of T years.

For example, you pay a flat rate of 5.32% quarterly on a notional amount 10 MM USD (\displaystyle (\text(10 MM USD))) in exchange for TIBOR USD 3M (\displaystyle (\text(TIBOR USD 3M))) also quarterly on notional amount 1.2 billion yen over 3 years.

Under a non-deliverable swap, the dollar equivalent of interest payments on the yen will be paid/received in accordance with the USD/JPY rate in effect on the fixing date for the value date of the interest payment. There is no exchange of principal amounts. Payments arise only when:

the arrival of the fixing date and
the beginning date of the swap (if the start date of the swap begins in the distant future relative to the date of the transaction).

Swaps F i x e d − f o r − f l o a t i n g (\displaystyle Fixed-for-floating) 2 currencies are used for exchange

assets/liabilities with a fixed rate in one currency for
floating rate assets/liabilities in another currency and vice versa.

For example, if a company

It has
- loan with a fixed rate of 5.3% for 10 million USD with monthly interest payments and
- investment in the amount of 1.2 billion JPY with a yield of 1M JPY Libor + 50 bp with monthly fixing and payments and
wants to fix income in US dollars, expecting that
- JPY 1M Libor rate will fall or
- USDJPY will rise (the value of the yen will fall against the dollar)

she can sign a contract f i x e d − f o r − f l o a t i n g (\displaystyle fixed-for-floating) IRS in two currencies, according to which it will be:

pay floating rate JPY 1M Libor+50 bp
receive a fixed rate of USD 5.6%,
thereby recording an income of 30 bp on the interest rate and currency position.

Floating-For-Floating, one currency

Side P

A, indexed by the curve X
receives (pays) a floating rate in foreign currency A, indexed by the curve Y for a notional amount N for a period of T years.

JPY LIBOR 1M (\displaystyle (\text(JPY LIBOR 1M))) monthly in exchange for JPY TIBOR 1M (\displaystyle (\text(JPY TIBOR 1M))) also monthly on notional amount 1 billion yen over 3 years.

swaps are used to hedge or speculate against a widening or narrowing spread between two indices.

For example, if a company

If the company

she can enter into an IRS contract in one currency in which she will, for example:

pay floating rate JPY TIBOR + 30 bps
receive a floating rate JPY LIBOR + 35 bps,
thereby locking in a 35bp return on the interest rate instead of the current 40bp spread and index risk. The nature of the 5 bp difference lies in the cost of the swap, which consists of
1. market expectations of changes in the spread between indices and
2. bid/offer spread, which is the swap dealer's commission

F l o a t i n g − f o r − f l o a t i n g (\displaystyle Floating-for-floating) swaps are also used when using the same index, but

with different interest payment dates or
using different conventions for defining business days.

These swaps are practically not used by speculators, but are important for managing assets and liabilities. An example is the 3M LIBOR swap,

paid prior non-business day convention, quarterly according to the JAJO rule (i.e. January, April, July, October) on the 30th, against
FMAN (i.e. February, May, August, November) 28 modified following.

Floating-For-Floating, 2 currencies

Side P

pays (receives) a floating rate in foreign currency A, indexed by the curve X
receives (pays) a floating rate in foreign currency B, indexed by the curve Y for a notional amount N at the original FX rate for the term T years.

For example, you pay a variable rate USD LIBOR 1M (\displaystyle (\text(USD LIBOR 1M))) quarterly in the amount of USD 10 million in exchange for JPY TIBOR 3M (\displaystyle (\text(JPY TIBOR 3M))) also monthly on notional amount 1.2 billion yen (at initial FX rate USD/JPY 120) over 4 years.

To understand this type of swap, consider an American company with operations in Japan. To finance its development in Japan, the company requires 10 billion yen. The simplest solution for a company would be to issue bonds in Japan. Since the company may be new to the Japanese market and may not have the required reputation among Japanese investors, issuing bonds may be an expensive option. In addition to all that has been said, the company may not have

an adequate insurance program for bond issues in Japan and
carry out developed treasury functions in Japan

To solve these problems, a company can issue bonds in the United States and convert dollars into yen. Although these actions solve the first problems, they create new risks for the company:

FX risk. If the USDJPY rate rises by the maturity date of the bonds, then when the company converts yen into dollars to pay off the debt on the bonds, it will receive fewer dollars and, accordingly, will incur exchange rate losses
Interest risk on USD and JPY. If yen rates fall, the profitability of a company's investments in Japan may fall - this gives rise to interest rate risk.

Currency risk can be eliminated by hedging using forward FX contracts, but this creates a new risk - the interest rate applied to determine the forward FX rate is fixed, while the return on investment in Japan has a floating structure.

Although there are several other options for hedging currency and interest rate risks, the simplest and most effective way is to enter into f l o a t i n g − f o r − f l o a t i n g (\displaystyle floating-for-floating) swap in two currencies. In this case, the company receives funds by issuing dollar bonds and swaps them in US dollars.

As a result, she

receives a floating rate in USD corresponding to its expenses for servicing the bonds issued to it and
pays a floating rate on JPY corresponding to its income on investments in yen.

Fixed-For-Fixed, 2 currencies

Side P

pays (receives) a fixed rate in foreign currency A,
receives (pays) a fixed rate in foreign currency B for a period of T years.

For example, you pay JPY 1.6% on notional amount 1.2 billion yen in exchange for USD 5.36% per equivalent notional amount 10 million dollars at the initial FX rate of 120 USDJPY.

Other variations

Other options are possible, although they are less common. They are mainly intended for perfect hedging the bond, ensuring full compliance of interest payments - on the bond and the swap. These options can give rise to swaps in which the principal is paid in one or more payments, as opposed to conventional swaps in which interest flows are simply exchanged - for example, to hedge coupon strip transactions.

Application

Interest rate swaps have applications in a wide variety of investment strategies. They are a popular tool for hedging and financial speculation.

Hedging

Fixing the interest rate under a swap agreement allows you to hedge against falling interest rates.

Speculation

Due to the low threshold for entering into an interest rate swap position, they are popular with traders speculating on interest rate movements.

So, instead of opening a full-fledged short position on an underlying asset for which the price is expected to fall, a trader only needs to enter into a swap agreement that fixes the interest rate for the same period.

Pricing

More information en:wiki Rational pricing

The value of a fixed leg is defined as the present value of the fixed interest payments known at the time of the transaction or at any time during its existence.

P V fixed = C × ∑ i = 1 M (P × t i T i × d f i) (\displaystyle PV_(\text(fixed))=C\times \sum _(i=1)^(M)(P\times (\frac (t_(i))(T_(i)))\times df_(i))) Where C (\displaystyle C)- swap rate M (\displaystyle M)- number of periods of fixed interest payments, P (\displaystyle P) t i (\displaystyle t_(i)) i (\displaystyle i), T i (\displaystyle T_(i)) d f i (\displaystyle df_(i))- discount factor.

The value of the floating leg of the swap is also calculated based on the present value of the floating interest payments determined at the time of the transaction. However, at the beginning of the swap, only the future interest payments on the fixed leg are known, while forward interest rates are used to approximate the interest rates on the floating leg.

Each floating interest payment is calculated based on forward interest rates for the relevant payment dates. Using these rates results in a series of interest payments. Each flow is discounted using a zero-coupon rate. Data from the rate curve available in the market is also used. Zero-coupon rates are used because these rates describe interest-free bonds that generate only one cash flow - as in our calculation case. Thus, an interest rate swap is treated as a series of zero-coupon bonds.

As a result, the cost of the floating leg of the swap is calculated as follows:

P V float = ∑ j = 1 N (P × f j × t j T j × d f j) (\displaystyle PV_(\text(float))=\sum _(j=1)^(N)(P\times f_(j )\times (\frac (t_(j))(T_(j)))\times df_(j))) Where N (\displaystyle N)- number of interest floating payments, f j (\displaystyle f_(j))- forward interest rate, P (\displaystyle P)- nominal amount of the transaction, t j (\displaystyle t_(j))- number of days in the interest period j (\displaystyle j), T j (\displaystyle T_(j))- financial base of the currency in accordance with the convention and d f j (\displaystyle df_(j))- discount factor. The discount factor always starts at 1.

The factor is calculated as follows:

d f C u r r e n t P e r i o d = d f P r e v i o u s P e r i o d 1 + F o r w a r d R a t e P r e v i o u s P e r i o d × Y e a r F r a c t i o n (\displaystyle (df_(CurrentPeriod))=(\frac (df_(PreviousPeriod))(1+ForwardRate_( PreviousPeriod)\times YearFraction))).

Fixed rate quoted on a swap transaction - a rate that gives the present value of fixed cash flows equal to the present value of floating interest flows, calculated at forward interest rates in effect on the calculation date:

C = P V float ∑ i = 1 M (P × t i T i × d f i) (\displaystyle C=(\frac (PV_(\text(float)))(\sum _(i=1)^(M)( P\times (\frac (t_(i))(T_(i)))\times df_(i)))))

At the time of conclusion of the transaction, none of the parties to the contract has an advantage in the cost of the legs of the swap, that is:

P V fixed = P V float (\displaystyle PV_(\text(fixed))=PV_(\text(float)))

Thus, at the time of conclusion of the transaction, no payments occur between the parties.

Over the life of the trade, the same pricing technique is used to estimate the value of the swap, but as forward rates change over time, the present value ( P V) the floating leg of the swap will be different from the unchanged fixed leg.

Consequently, the swap will become an obligation of one party and a requirement of the other - depending on the direction of changes in interest rates.

Risks

An interest rate swap position contains interest rate and credit risks for the parties to the contract.

An interest rate swap is an agreement between two partners to exchange interest obligations over a specified period of time. Interest rate swaps are used for the following purposes:

1) raising funds at a fixed rate when access to bond markets is impossible. If the company has sufficient creditworthiness, it obtains a loan at a floating rate and then uses a swap to exchange it for a fixed rate. As a result, funds are raised by the company at a fixed percentage;

2) raising funds at a rate lower than that currently prevailing on the bond market or credit market. As a result of the swap, a borrower with high creditworthiness attracts funds at a floating rate lower than what the banks offered him. A borrower with low creditworthiness attracts funds at a fixed rate, which, taking into account his creditworthiness, would hardly be possible at all or would be higher;

3) restructuring a portfolio of liabilities or assets without attracting new funds. In this case, with the help of swaps, the ratio between the shares of liabilities or assets with floating and fixed rates changes.

Most often, an interest rate swap is used to replace a fixed interest rate with a floating one and less often to replace one floating rate with another.

When concluding swap transactions, participants are guided by unified international and national standards and rules. Agreements for each swap agreement are not concluded; the parties sign one agreement, which governs all their further relationships when conducting swap transactions. Swap agreements are concluded over the telephone. It is not necessary that interest payments coincide in time. For example, one party may make payments monthly, the other quarterly. The minimum volume of swap transactions is $5 million CIPL.

There are two types of interest rate swaps: pure and basis.

A pure interest rate swap is an agreement between partners to exchange a fixed-rate interest-bearing obligation for a floating-rate obligation. In this case, the participants in the swap exchange interest payments, and not obligations in full. Payments on swaps are usually made in the amount of the difference between interest rates, and not in the amount of the interest rates themselves.

The amount of debt on which interest payments are made is called the principal amount or face value of the swap. Interest payments are calculated on the basis of specified rates and a certain principal amount. The exchange of interest payments allows each participant in the swap to change the structure of its debt to one that is more suitable for its needs. A pure interest rate swap that exchanges a fixed rate for a floating rate in one currency is also called a “vanilla swap.”

An interest rate swap is not a credit agreement. Each borrower participating in the swap fulfills obligations to its lender, paying both interest and principal. Lenders receive interest payments on the debt without determining whether they are received as a result of the swap or directly from the borrower. As a rule, banks are permanent participants in swaps, acting either as intermediaries or as direct participants in the exchange of interest payments. Acting as an intermediary, banks receive and make payments on the swap to each of the swap participants and isolate the swap participants from each other.

An example of a swap would be an agreement between a commercial bank and a corporation in the United States to exchange interest payments annually for five years based on an amount (the face value of the swap) of $100 million. According to this agreement, the bank agrees to pay the corporation annually 9% of the face value, that is, $9 million. The corporation then annually pays the bank an interest rate on one-year Treasury bills. If in one year the interest rate on the obligations is 6%, the corporation will pay the bank $6 million for that year.

Let's consider the mechanism of operation of an interest rate swap using an example (Fig. 11.1). Company A, rated AAA, issued bonds with a fixed coupon of 10% in the amount of $10 million. In the floating rate obligation market, it has the opportunity to raise funds at a rate of LIBOR + 100 bps.

Rice. 11.1. Payment scheme for interest rate swap

The companies decide to enter into an interest rate swap agreement whereby Company A will pay Company B (and subsequently its lender) a floating interest rate of LIBOR, and Company B will pay A a fixed interest rate of 9.5%.

Let's analyze the interest payments made by companies A and B. A pays a fixed percentage of 10% to bondholders (creditors of the company). From the corporation - participant in the swap, B receives interest payments in the amount of 9.5%, corporation B pays the LIBOR rate.

As a result of the swap transaction, Corporation A pays a floating rate equal to LIBOR + 50 bps, which is 50 bps higher. less than the rate at which it could directly raise funds in the market.

Company B pays the bulk, its credit has fallen, the rate is LIBOR + 150 bp. Company A pays a fixed percentage (9.5%). From company A receives a floating interest rate LIBOR. Company B's final interest payments are fixed at 11%, which is 50 bps. less than the rate of direct attraction of funds on the market.

So, each of the companies participating in the swap was able to change the structure of their interest payments on the debt. B replaced payments at a floating interest rate with fixed payments, and switched to paying a floating rate. In addition, both companies received access to interest rates of 50 bp. There are fewer rates at which investors could directly raise funds on the market. This win

in interest rates is due to the different relative advantages of companies A and B in the fixed and floating rate markets.

Let's consider interest payments on a swap in the case where a bank acts as a financial intermediary in organizing the swap. If in the previous example the swap participants distributed the winnings of 100 bp. equally among themselves, then in this case the share of the winnings falls on the commercial bank, which acts as the organizer of the swap. What is a gain from a transaction for swap participants is income received for financial intermediation in such a transaction for the bank. The swap payment scheme is shown in Fig. 11.2.

Rice. 11.2. Swap payment scheme through the intermediary of a bank

Proceedings of payments at the floating LIBOR rate from A to B occur through the bank. When a fixed interest rate passes through the bank, a positive difference of 0.1% remains in it (9.55% - "9.45% = 0.1%). Multiplied by The principal settlement amount (debt amount) of 0.1% will be the bank's profit from intermediary in this transaction.The payments that are made by companies A, B and the intermediary bank in this swap are shown below.

So, as a result of the swap, companies A and B received access to the desired interest rates (floating and fixed), and these rates were 45 bp. lower rates for directly raising funds on the market. The bank made a profit of 0.1%, or 10 bps. If swap payments are made once a year, the profit received by the bank for this period will be equal to 0.1% of the principal amount, that is, 0.001 10000000 = $10,000.

Today, the financial intermediary's remuneration for conducting a swap ranges from 5 to 10 basis points. Banks enter into separate agreements with each of the swap participants, and these agreements act as separate swaps. The benefits of a swap may vary for different swap participants depending on the market situation. Thus, significant demand for fixed-rate financing leads to an increase in premiums from swaps towards borrowers with high credit ratings.

So, the main goals that swap participants can set are the desire to change the structure of interest payments on the debt, gain access to lower rates and benefit. The desire to replace floating rate payments with fixed interest payments may be driven by expectations of rising interest rates in the market. When interest rates are expected to fall in the market, there is a desire to replace fixed-rate obligations with floating-rate obligations. Borrowers with high credit ratings use swap transactions to leverage their comparative advantage in the fixed rate market and gain a better position in the floating rate market. Borrowers of this class include banks, governments and corporations with a credit rating of ALA, AA.

Industrial corporations with lower credit ratings (BOB and lower) may resort to swap transactions and the replacement of a floating interest rate with a fixed one, since they are unable to raise funds at an acceptable fixed rate in the bond market. Commercial banks turn to the swap market to balance their fixed and floating rate assets and liabilities and thereby reduce interest rate risk, which is one of the main banking risks.

A basis swap is an agreement between participants to exchange a floating interest rate on a debt calculated on one basis for a floating interest rate calculated on another basis. For example, a floating rate based on LIBOR may be exchanged for a commercial paper interest rate. Interest rate exchange payments may also be calculated on the same price basis, but for different price periods. For example, a 6-month LIBOR could be exchanged for a 1-month LIBOR. Floating rates with different price bases and periods can also be exchanged.

Basis swaps are used primarily to transition to the desired repo of financial instruments or to cover floating rate obligations under other swaps. This type of swap is less common than a pure interest rate swap.

An interest rate swap is an over-the-counter transaction in which two parties exchange interest payments on loan obligations of equal amounts, but with different interest rates. Interest rate swaps are typically long-term instruments whose purpose is similar to that of an agreement on a future interest rate, but the duration for major currencies ranges from 2 to 10 years. Essentially, an interest rate swap is equivalent to an agreement on a future interest rate.

Interest rate swap is an agreement between parties to make a series of payments to each other on agreed dates before the end of the agreement. The amount of interest payments of each party is calculated based on different formulas, based on notional principal amount agreements.

A typical transaction of this type involves exchanging the interest payment on the instrument with fixed rate, for example a coupon bond, on an interest payment with floating rate.

Interest rate swaps are traded over the counter and are one of the most widely used money market instruments in the world.
The simplest tools include fixed/floating rate swap, in which one of the counterparties makes payments at a fixed interest rate, and the other at a floating interest rate, tied to a reference rate, for example LIBOR. Since an interest rate swap does not involve delivery of principal, interest accrues on the notional amount.
An interest rate swap is an instrument of two counterparties borrowing the same amount at interest rates on different bases and then exchanging interest payments.
Since there is no exchange of principal, credit risk is limited to the interest payments received from the counterparty. Most often, only the difference between the gross interest payments of counterparties is paid in settlements, so credit risk is limited to the net cash flow.

The point of interest rate swaps is that they allow borrowers to decouple the basis on which they pay interest from the underlying money market instrument used to actually borrow.
Thus, a borrower who wants to pay a fixed annual interest rate on a loan with a maturity of one year, but can only obtain financing in the form of short-term 3-month commercial paper, can use an interest rate swap that allows him receive 3 month rate LIBOR And pay annual fixed rate. Each time the 3-month commercial paper is redeemed, it is simply renewed.
Thus, the borrower pays a 3-month interest rate on the loan LIBOR and under the swap receives a payment at a 3-month rate LIBOR in exchange for payment of a fixed annual interest rate. As a result of this exchange, his net payment represents an annual fixed interest.
This fixed/floating rate swap is called simple interest rate swap(plain vanilla interest rate swap).
There are also floating/floating rate swaps, which are also called basic(basis swap) or differential(diff swap) swaps.

Conditions and characteristics
Items that require approval when entering into an interest rate swap agreement include the following:

Effective date. The date on which interest begins to accrue on both sides of the swap. For simple interest rate swaps, this is the spot rate and the LIBOR rate fixed on the day the transaction is concluded. The conditions here are the same as in the case of money market deposits.

Date of completion. The contract or maturity date for which the final interest payment is calculated.

Notional amount. The amount used to calculate the interest payments of both parties.

Payer/receiver of a fixed rate. Since in most swaps payments are made by both parties, one at a fixed rate and the other at a floating rate, referring to the counterparties as “buyer” and “seller” can be misleading. In this regard, one of the counterparties is usually called the fixed rate payer, and the other - the fixed rate recipient.