Interest rate swap
Also called: IRS, Overnight indexed swap, OIS · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT
Meaning
An interest rate swap (IRS) is a deal in which two parties exchange interest payments on an agreed amount called the notional principal. Usually one side pays a fixed rate and the other pays a floating rate, which changes with a benchmark. Only the interest payments are exchanged; the principal itself never changes hands. Swaps help banks and firms manage the risk of interest rates changing. An overnight indexed swap (OIS) is a type of IRS in which the floating payments are linked to an overnight rate. In India, that rate is MIBOR, the overnight interbank lending rate published by FBIL (Financial Benchmarks India Ltd).
Example
A company has a floating-rate loan of Rs 100 crore and fears that rates will rise. It enters an OIS in which it pays a fixed rate and receives MIBOR-linked payments on a notional Rs 100 crore. If rates rise, the higher payments it receives offset the higher interest on its loan.
Don't confuse with
- Currency swap: this exchanges payments in two different currencies, not fixed for floating interest in the same currency.
Related concepts
- Derivatives
- Forward contract
- Futures
- Options
- Swap
- Credit default swap
- Commodity derivatives
- Hedging
- Arbitrage
- Futures and options trading