Swaps are spin-off contracts between two parties that involve the exchange of cash courses. Interest rate swaps involve exchanging interest payments, while currency swaps betoken exchanging an amount of cash in one currency for the same amount in another.
Involvement business Rate Swaps
An interest rate swap is a financial derivative promise in which two parties agree to exchange their interest rate gelt flows. The interest rate swap generally involves exchanges between prearranged notional amounts with fixed and floating rates.
For example, guess bank ABC owns a $10 million investment, which pays the London Interbank Submitted Rate, or LIBOR, plus 3% every month. Therefore, this is rated a floating payment because as the LIBOR fluctuates, so does the cash swirl. On the other hand, assume bank DEF owns a $10 million investment, which give outs a fixed rate of 5% every month. Bank ABC decides it intent rather receive a constant monthly payment. However, bank DEF takes to take a chance on receiving higher payments. Therefore, the two banks tally to enter into an interest rate swap contract. Bank ABC accepts to pay bank DEF the LIBOR plus 3% per month on the notional amount of $10 million. Bank DEF agrees to pay bank ABC a fastened 5% monthly rate on the notional amount of $10 million.
Conversely, currency swaps are a transalpine exchange agreement between two parties to exchange cash flow surges in one currency to another. While currency swaps involve two currencies, incline rate swaps only deal with one currency.
For example, adopt bank XYZ operates in the United States and deals only with U.S. dollars, while bank QRS serves in Russia and deals only with rubles. Suppose bank QRS has investments in the Unanimous States worth $5 million. Assume the two banks agree to write into a currency swap. Bank XYZ agrees to pay bank DEF the LIBOR return 1% per month on the notional amount of $5 million. Bank QRS agrees to pay bank ABC a bent 5% monthly rate on the notional amount of 253,697,500 Russian rubles, using $1 is equal to 50.74 rubles.