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interest rate swaps

An interest rate swap is an agreement between two parties to exchange interest payments (in the same currency) for a specific maturity on an agreed-upon notional amount. No principal is exchanged in an interest rate swap. The notional amount or notional principal is a reference amount needed to calculate the interest rate.

The most common type of interest rate swaps are fixed-to-floating swaps, in which party A receives floating-rate payments from party B in exchange for fixed-rate payments from A to B. This is done in order to achieve savings on the total interest cost, as one party usually has a comparative advantage in borrowing at a fixed or floating rate.

Using this relatively straightforward mechanism, interest rate swaps transform debt issues, assets and liabilities from fixed-to-floating or vice-versa.