Interest rate swap
An interest rate swap is an agreement between two parties to exchange interest payments on a set amount of money, called the notional amount, without exchanging that principal itself. In the most common version, one party pays a fixed interest rate while the other pays a floating rate that resets periodically based on a reference rate, and only the difference between the two payments changes hands.
Companies use interest rate swaps to change the nature of their exposure to interest rates without refinancing their actual debt. A company that issued debt at a floating rate but wants the certainty of fixed payments can enter a swap to pay fixed and receive floating, effectively converting its floating rate debt into a fixed obligation for the purposes of its own cash flow, while the underlying themselves remain unchanged. A company that instead expects rates to fall can do the opposite, converting fixed obligations into floating ones to benefit if rates decline.
Interest rate swaps are also a core tool for banks and asset managers managing the interest rate sensitivity of large , since the swap market allows exposure to be adjusted without having to buy or sell the underlying directly. Pricing in the swap market, particularly the rate at which fixed and floating payments are considered equal in value, is closely watched as a signal of where the market expects interest rates to head, making swap rates a widely used input alongside for gauging the market's outlook on future monetary policy.