Interest Rate Swaps enable financial institutions to better manage their risks arising out of interest rate fluctuations. In a Single Currency Interest Rate Swap (IRS), two parties agree to exchange their interest receipts on a notional principal investment in a single currency at regular intervals over an agreed duration.
Interest Rate Swaps
Manage your interest rate exposure with swaps
You can enter into two types of interest rate swaps: The Fixed to Floating Swap and the Floating to Floating Rate Swap
In a fixed to floating interest rate swap, a customer receives cash flows at a fixed rate of interest and simultaneously pays out at a floating rate of interest or vice versa. The interest is calculated on a notional principal amount. The floating rate of interest is usually referenced to a transparent benchmark like MiBOR or Mumbai Inter-Bank Offer Rate.
In floating to floating swap, two parties exchange receipts on a notional principal based on a floating interest rate referenced to two different benchmarks.
The trade date is the date two parties agree on the conditions of the swap.
The effective date is when the swap becomes effective, i.e. when interest pay outs begin.
Maturity date is the date the swap stops accruing interest and terminates.
Swaps are usually quoted in the market against standard benchmark or index rates on non-amortising notional principal, free from the margin payable in the cash market by the relevant parties. The rate is thus a flat one and any amortising structure that involves a customised rate is adjusted accordingly.
Here’s an example of an interest rate swap:
A quote of 9.75% - 10.25% against 3-month MIBOR means that the market maker:
Pays (bid) 9.75% fixed and receives INR 3-month MIBOR
Receives (ask/ offer) 10.5% fixed and pays INR 3-month MIBOR
Any transparent benchmark may be used as a reference rate.
Some examples* of the floating rate benchmarks are as follows:
Overnight money rate or MIBOR
Treasury Bills yield to maturity
Term money rate
Government Securities yield to maturity
* Not all are these benchmarks are currently available in India
Banks, primary dealers and financial institutions can enter into rupee IRSes to hedge their exposure and for market making. Corporate customers can enter into rupee IRSes only to hedge the interest rate risk on an underlying asset of liability.
All participants can enter into non-rupee IRSes only to hedge an underlying exposure.
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