Fixed-for-Floating Swap
A fixed-for-floating swap is a contractual arrangement between two parties in which one party swaps the interest cash flows of fixed-rate loan(s) with those of floating-rate loan(s) held by another party. There are a few main motivations for a loan holder to execute a fixed-for-floating swap: Reduce interest expense by swapping for a floating rate if it is lower than the fixed-rate currently being paid; Better match assets and liabilities that are sensitive to interest rate movements; Diversify risks in a total loan portfolio by exchanging a portion of a fixed rate to floating rate; and/or Perform a financial hedge with an expectation that market interest rates will decline. Suppose Company X carries a $100 million loan at a fixed rate of 6.5%. With the fixed-for-floating swap Company X will pay the floating rate, and thus benefit if in fact interest rates drop, and Company Y will assume payments for the fixed-rate loan. A fixed-for-floating swap occurs when one party swaps the interest cash flow of a fixed-rate loan with those of a floating-rate loan held by another party. A fixed-for-floating swap is a contractual arrangement between two parties in which one party swaps the interest cash flows of fixed-rate loan(s) with those of floating-rate loan(s) held by another party.
What Is a Fixed-for-Floating Swap?
A fixed-for-floating swap is a contractual arrangement between two parties in which one party swaps the interest cash flows of fixed-rate loan(s) with those of floating-rate loan(s) held by another party. The principal of the underlying loans is not exchanged.
Understanding Fixed-for-Floating Swap
There are a few main motivations for a loan holder to execute a fixed-for-floating swap:
Example of a Fixed-for-Floating Swap
Suppose Company X carries a $100 million loan at a fixed rate of 6.5%. Company X expects that the general direction of interest rates over the near or intermediate-term is down. Company Y, carrying a $100 million loan at London Interbank Offered Rate (LIBOR) + 3.50% (floating rate loan), has the opposite view; it believes interest rates are on the rise. Company X and Company Y wish to swap. With the fixed-for-floating swap Company X will pay the floating rate, and thus benefit if in fact interest rates drop, and Company Y will assume payments for the fixed-rate loan. Company Y will stand to benefit if interest rates rise. Swap transactions are facilitated by a swap dealer, who will act as the required counterparty for a fee.
Related terms:
Accounting
Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more
Amortizing Swap
An amortizing swap is an interest rate swap where the notional principal amount is reduced at the underlying fixed and floating rates. read more
Counterparty
A counterparty is the party on the other side of a transaction, as a financial transaction requires at least two parties. read more
Derivative
A derivative is a securitized contract whose value is dependent upon one or more underlying assets. Its price is determined by fluctuations in that asset. read more
Fixed Price
Fixed price can refer to a leg of a swap where the payments are based on a constant interest rate, or it can refer to a price that does not change. read more
Fixed Interest Rate
A fixed interest rate remains the same for a loan's entire term, making long-term budgeting easier. Some loans combine fixed and variable rates. read more
Floating Price
The floating price is a leg of a swap contract that depends on a variable, including an interest rate, currency exchange rate or price of an asset. read more
Floating Interest Rate
A floating interest rate is an interest rate that moves up and down with the rest of the market or along with an index. read more
Inflation Swap
An inflation swap allows one to transfer inflation risk to a counterparty in exchange for a fixed payment. read more
London Interbank Offered Rate (LIBOR)
LIBOR is a benchmark interest rate at which major global lend to one another in the international interbank market for short-term loans. read more