What Is An Interest Rate Swap (IRS)?

An Interest Rate Swap is a financial derivative which is a contract between two parties agreeing to exchange their cash flows from interest rates. This can be done in a variety of ways:

  • Fixed rate for floating rate
  • Fixed rate for fixed rate
  • Floating rate for fixed rate
  • Floating rate for floating rate

Interest Rate Swaps can be undertaken in the same currency or in different currencies and are most commonly used for hedging against interest rate risk, or for speculation on monetary policy. For example, if a hedge fund believes that Chinese interest rates are going to rise to prevent inflation but that US rates are going to stay low, they can purchase fixed Dollar / floating Yen Interest Rate Swaps, so the interest they pay on the dollar will stay the same whilst the interest they receive on the Yen will increase, leading to profits.

To learn more about this concept and become a master at bonds and fixed income, you should check out our Bond Course - Fixed Income (coming soon!).

 

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