Fixed Income Securities, 4th Edition

CHAPTER 13Interest Rate Swaps

Interest rate swaps (IRS) are contracts in which two counterparties agree to exchange a sequence of interest payments on some notional amount of currency. In an overnight index swap (OIS), payments based on a fixed rate of interest are exchanged for payments based on a floating, overnight rate, which changes daily with market conditions. The swaps introduced in Chapter 2 are OIS, in which the floating rate is the Secured Overnight Financing Rate (SOFR) defined and discussed in Chapters 10 and 12. A fixed‐for‐floating swap is similar, but the floating rate is a term rate, rather than an overnight rate. Euribor swaps are fixed‐for‐floating swaps, in which the floating rate is typically the three‐month Euribor rate described in Chapter 12. Historically, the most common IRS across currencies were fixed‐for‐floating London Interbank Offered Rate (LIBOR) swaps, in which the floating rate was LIBOR of some term. However, with the transition away from LIBOR, as described in Chapter 12, these swaps are disappearing. OIS and fixed‐for‐floating swaps are the main focus of this chapter.

There are several classes of derivatives closely related to IRS, including forward‐rate agreements (FRAs) (see Chapter 12), caps and floors, and swaptions (see Chapter 16). While traditionally not called “swaps” by the financial industry, these products are defined as “swaps” in the Dodd‐Frank Act, which can cause some terminological confusion. In any case, these products are ...