the swap rate
the swap rate is a special kind of interest rate that is utilized for the calculation of fixed payments in a derivative instrument called an interest rate swap an interest rate swap is a financial contract between two parties who agree to exchange interest rate cash flows based on a notional amount for an interest rate swap there are two 2 types of interest rates required a fixed interest rate and a floating interest rate the fixed rate is the predetermined rate that one party agrees to pay while the floating rate is based on a reference rate such as a government bond yield the swap rate specifically refers to the fixed rate that is agreed upon in the swap contract it is the interest rate at which one party will make fixed payments to the other party over the life of a swap the swap rate remains constant throughout the duration of the swap agreement generally swap rates are determined by market forces such as supply and demand as well as expectations of future interest rate movements swap rates are influenced by factors such as prevailing interest rates credit risk liquidity conditions and market participants expectations swap rates are used in various financial applications one example involves companies and investors entering into an interest rate swap to manage interest rate risk by swapping fixed and floating rate cash flows parties can effectively convert their exposure to interest rate fluctuations swap rates also play a role in pricing other financial instruments such as structured products bonds and loans 1key components of a swap ratebelow shows the components of a swap rate key steps in a swapthese steps are generic and swap details may vary depending on the type of swap the jurisdiction and the needs of the parties 2examples of a swapassume that there are two 2 parties company apricot and company beetle they have reviewed the terms and conditions and agree to enter into an interest rate swap the terms of the swap are company apricot is the fixed rate payer and agrees to pay a fixed rate of 4 per annum on the notional amount while company beetle the floating rate payer agrees to pay a floating rate based on 3 month euribor plus a spread of 1 at the initiation date of the swap the 3 month euribor rate is 2 and the payment frequency is quarterly on each payment date which is every three months the following cash flows occur company apricot pays company beetle the fixed interest payment fip fr na pf fip 0 04 10 000 000 4 100 000 where fip fixed interest payment fr fixed rate na notional amount pf payment frequency begin aligned bullet text fip frac text fr times text na text pf bullet text fip frac 0 04 times 10 000 000 4 100 000 textbf where text fip text fixed interest payment text fr text fixed rate text na text notional amount text pf text payment frequency end aligned fip pffr na fip 40 04 10 000 000 100 000where fip fixed interest paymentfr fixed ratena notional amountpf payment frequency company beetle pays company apricot the floating interest payment flip 3 month euribor spread na pf flip 0 02 0 01 10 000 000 4 75 000 where flip floating interest payment na notional amount pf payment frequency begin aligned bullet text flip frac 3 text month euribor text spread times text na text pf bullet text flip frac 0 02 0 01 times 10 000 000 4 75 000 textbf where text flip text floating interest payment text na text notional amount text pf text payment frequency end aligned flip pf 3 month euribor spread na flip 4 0 02 0 01 10 000 000 75 000where flip floating interest paymentna notional amountpf payment frequency these cash flows continue for the duration of the swap tenor which is 5 years at each payment date the fixed rate payer company apricot pays a fixed interest amount and the floating rate payer company beetle pays a floating interest amount based on the reference rate 3 month euribor plus the spread there are three types of interest rate exchanges for a currency swap the swap can include or exclude a full exchange of the principal amount of the currency at both the beginning and the end of the swap the interest rate payments are not netted because they are calculated and paid in different currencies regardless of whether or not the principal is exchanged a swap rate for the conversion of the principal must be set if there is no exchange of principal then the swap rate is simply used for the calculation of the two notional principal currency amounts on which the interest rate payments are based if there is an exchange where the swap rate is set can have a financial impact since the exchange rate can change between the start of the agreement and its conclusion 