Simple English definitions for legal terms
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A plain-vanilla swap is an agreement between two parties to exchange interest payments. One party pays a fixed interest rate while the other pays a floating interest rate based on the amount of the underlying debt. The underlying debt, called the "notional" amount, does not change hands, only the interest payments are exchanged. This type of swap is used to manage risk, speculate on interest rate changes, or convert an instrument from a fixed to a floating rate or vice versa.
A plain-vanilla swap is an agreement between two parties to exchange interest payments or obligations. This is usually 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 in this agreement are called counterparties.
A typical example of a plain-vanilla swap involves one party paying a fixed interest rate while the other party assumes a floating interest rate based on the principal amount of the underlying debt. The underlying debt, also known as the "notional" amount of the swap, does not change hands. Only the interest payments are exchanged.
For instance, let's say 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 LIBOR rate. Company A may want to convert its fixed interest rate to a floating rate, while Company B may want to convert its floating rate to a fixed rate. They can enter into a plain-vanilla swap agreement where Company A pays a fixed interest rate to Company B, and Company B pays a floating interest rate to Company A based on the notional amount of the swap.