Interest rate swap
An agreement to exchange fixed-rate for floating-rate interest payments on a notional amount that itself never changes hands. It converts debt from one type to the other without refinancing it.
Where you will meet it
Interest rate swap appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Explain the I-spread and curves built from swap rates
“The swap rate curve is the term structure of fixed rates on interest rate swaps, and it serves as a benchmark in markets where the government curve is distorted by scarcity, regulation or central bank purchases.”
- Contrast how issuers use derivatives with how investors use them
“An issuer uses derivatives to manage risks arising from its own operations: an interest rate swap converting floating debt to fixed, a currency forward locking in the domestic value of foreign revenue, a commodity hedge fixing an input cost.”
- Explain the pricing of equity swaps, and work out their no-arbitrage value and say what it means
“Its fixed rate equals the plain interest rate swap rate for the same dates: (1 − final discount factor) ÷ sum of discount factors, because the equity leg resets to notional at each settlement.”
- Set out the main methods for allocating assets relative to liabilities
“The hedging/return-seeking approach splits assets into a portfolio matched to the liabilities, often with duration-matched bonds or interest rate swaps, and a separate portfolio seeking growth; variants include partial hedging and conditional strategies that raise the hedge as funded status improves.”
Practise it
Practise interest rate swap until it is automatic: questions that explain every wrong option.
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