Editing Interest rate swap (section)

==Interest rate swaps==
{{More citations needed|section|date=July 2021}}

===General description===
[[File:IRSflows.png|frame|right|Graphical depiction of IRS cashflows between two counterparties based on a notional amount of EUR100mm for a single (i'th) period exchange, where the floating index <math>r_i</math> will typically be an -IBOR index]]
An interest rate swap's (IRS's) effective description is a derivative contract, agreed between two [[counterparty|counterparties]], which specifies the nature of an exchange of payments benchmarked against an interest rate index. 
The most common IRS is a fixed for floating swap, whereby one party will make payments to the other based on an initially agreed fixed rate of interest, to receive back payments based on a floating interest rate index. 
Each of these series of payments is termed a "leg", so a typical IRS has both a fixed and a floating leg. 
The floating index is commonly an [[interbank rate|interbank offered rate]] (IBOR) of specific tenor in the appropriate currency of the IRS, for example [[LIBOR]] in GBP, [[EURIBOR]] in EUR, or STIBOR in SEK.

To completely determine any IRS a number of parameters must be specified for each leg:<ref name=PTIRDs>[http://www.tradinginterestrates.com Pricing and Trading Interest Rate Derivatives: A Practical Guide to Swaps], J H M Darbyshire, 2017, {{ISBN|978-0995455528}}</ref>
*the [[notional principal amount]] (or varying notional schedule); 
*the start and end dates, [[Value date|value-]], [[Trade date|trade-]] and [[settlement date]]s, and date scheduling ([[date rolling]]); 
*the fixed rate (i.e. "[[swap rate]]", sometimes quoted as a "[[swap spread]]" over a benchmark); 
*the chosen floating interest rate index [[tenor (finance)|tenor]]; 
*the [[day count convention]]s for interest calculations.

Each currency has its own standard market conventions regarding the frequency of payments, the day count conventions and the end-of-month rule.<ref>"[https://quant.opengamma.io/Interest-Rate-Instruments-and-Market-Conventions.pdf Interest Rate Instruments and Market Conventions Guide]" Quantitative Research, OpenGamma, 2012.</ref>

===Extended description===
{| class="wikitable floatright" | width="250"
|- style="text-align:center;"
|There are several types of IRS, typically:
|-
|
* "Vanilla" fixed for floating
* [[Basis swap]]
* [[Currency swap|Cross currency basis swaps]]
* [[Amortising swap]]
* [[Zero coupon swap]]
* [[Constant maturity swap]]
* [[Overnight indexed swap]]
|}
As [[Over-the-counter (finance)|OTC]] instruments, interest rate swaps (IRSs) can be customised in a number of ways and can be structured to meet the specific needs of the counterparties. 
For example: payment dates could be irregular, the notional of the swap could be [[Amortising swap|amortized]] over time, reset dates (or fixing dates) of the floating rate could be irregular, mandatory break clauses may be inserted into the contract, etc. 
A common form of customisation is often present in '''new issue swaps''' where the fixed leg cashflows are designed to replicate those cashflows received as the coupons on a purchased bond. 
The [[interbank market]], however, only has a few standardised types.

There is no consensus on the scope of naming convention for different types of IRS. 
Even a wide description of IRS contracts only includes those whose legs are denominated in the same currency. 
It is generally accepted that swaps of similar nature whose legs are denominated in different currencies are called [[Currency swap|cross currency basis swaps]]. 
Swaps which are determined on a floating rate index in one currency but whose payments are denominated in another currency are called [[Quanto]]s.

In traditional interest rate derivative terminology an IRS is a '''fixed leg versus floating leg''' derivative contract referencing an '''IBOR''' as the floating leg. 
If the floating leg is redefined to be an [[overnight rate|overnight index]], such as EONIA, SONIA, FFOIS, etc. then this type of swap is generally referred to as an '''overnight indexed swap (OIS)'''. 
Some financial literature may classify OISs as a subset of IRSs and other literature may recognise a distinct separation.

'''Fixed leg versus fixed leg''' swaps are rare, and generally constitute a form of specialised loan agreement.

'''Float leg versus float leg''' swaps are much more common. These are typically termed (single currency) [[basis swap]]s (SBSs). The legs on SBSs will necessarily be different interest indexes, such as 1M LIBOR, 3M LIBOR, 6M LIBOR, SONIA, etc. The pricing of these swaps requires a '''spread''' often quoted in basis points to be added to one of the floating legs in order to satisfy value equivalence.

===Uses===
Interest rate swaps are used to hedge against or speculate on changes in interest rates. They are also used to manage cashflows by converting floating to fixed interest payments, or vice versa.

Interest rate swaps are also used speculatively by hedge funds or other investors who expect a change in interest rates or the relationships between them. Traditionally, fixed income investors who expected rates to fall would purchase cash bonds, whose value increased as rates fell. Today, investors with a similar view could enter a floating-for-fixed interest rate swap; as rates fall, investors would pay a lower floating rate in exchange for the same fixed rate.

Interest rate swaps are also popular for the [[arbitrage]] opportunities they provide. Varying levels of [[creditworthiness]] means that there is often a positive [[quality spread differential]] that allows both parties to benefit from an interest rate swap.

The interest rate swap market in USD is closely linked to the [[Eurodollar]] futures market which trades among others at the [[Chicago Mercantile Exchange]].