Contents: Interest rate swap basics 2
Excel work 4
References 8

Interest rate swap basics
Swaps, being highly liquid derivatives, are not traded on stock exchange, but facilitated by over-the-counter (OTC) trading. Interest rate swap is an arrangement between two parties whereby they exchange one set of interest payment for another. The most widespread arrangement is when fixed-rate interest payments are exchange for floating-rate interest payment on some notional amount over the time. This notional amount is generally not exchanged between counterparties, but is used only for calculation of the size of cash flows to be exchanged, and what is more, usually only resulting cash flow (difference between fixed and floating interest rate payments) is paid.
The simplest swap structure is a vanilla interest rate swap, in which one party receives a fixed interest rate agreed in advance and the other party a variable interest rate. The provisionы of such a swap are the following:
• Notional (value to which interest rates are applied to)
• Fixed interest rate
• Floating interest rate
• Frequency of payments
• Contract period
Most swaps are arranged so that their value is zero at the starting date. For US dollar swaps, floating rates are typically the 3-month or 6-month LIBOR rates prevailing over the period before the interest payment is made. The interest rates are determined in advance or equivalently, the payments are made in arrears. In practice, there are many variants of this basic structure. For instance, swaps can be such that the nationals are different for the two counterparties, or the notional(s) amortize, or where the floating leg is LIBOR plus or minus a fixed coupon, etc.
Swaps are usually used for hedging and reducing interest rate risk.
Present value of vanilla interest rate swap can be calculated using standards methods of determining