14:51
I stg every time I see you that Jorge Ben song starts playing in my head again
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LSDefine
Simple English definitions for legal terms
interest-rate swap
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A quick definition of interest-rate swap:
An interest-rate swap is an agreement between two parties to exchange interest payments or obligations. This is done to manage risk, speculate on interest-rate changes, or convert an instrument from a fixed to a floating rate or vice versa. The parties involved are called counterparties. In a plain-vanilla swap, one party pays a fixed interest rate while the other pays a floating interest rate based on the principal amount of the underlying debt. The notional amount of the swap, which is the underlying debt, does not change hands, only the interest payments are exchanged.
A more thorough explanation:
An interest-rate swap is an agreement between two parties to exchange interest receipts or interest-payment obligations. This is usually done to adjust one's risk exposure, speculate on interest-rate changes, or convert an instrument or obligation from a fixed to a floating rate or vice versa. The parties involved in this agreement are called "counterparties."
A plain-vanilla swap is a typical interest-rate swap that involves one counterparty paying a fixed interest rate while the other assumes a floating interest rate based on the amount of the principal of the underlying debt. The underlying debt, called the "notional" amount of the swap, does not change hands, only the interest payments are exchanged.
Company A has a loan with a fixed interest rate of 5%, while Company B has a loan with a floating interest rate based on the prime rate. Company A is concerned that interest rates may rise, while Company B is concerned that interest rates may fall. They enter into an interest-rate swap agreement where Company A pays Company B a fixed interest rate of 4%, and Company B pays Company A a floating interest rate based on the prime rate. This way, Company A can protect itself from rising interest rates, while Company B can protect itself from falling interest rates.
This example illustrates how an interest-rate swap can be used to adjust one's risk exposure and protect against potential losses due to interest-rate changes.