Interest Rate Swap (IRS)
An interest rate swap is a contract in which two parties exchange interest payments calculated on the same notional amount, typically one paying a fixed rate and the other a floating rate, without exchanging the principal itself.
Also called: IRS · interest rate swaps · fixed-for-floating swap · plain vanilla swap
In the standard form, one party pays a fixed rate agreed at the outset and the other pays a floating rate reset periodically against a benchmark, both on the same notional amount and in the same currency. The principal never changes hands; on each payment date only the difference between the two legs is usually paid, an application of netting. In US dollars the floating leg now references SOFR: the US dollar LIBOR panel ended on 30 June 2023 and the last synthetic LIBOR settings ceased on 30 September 2024.
Swaps let a borrower or investor change the character of its interest rate exposure without refinancing. A company with a floating-rate loan can pay fixed and receive floating to turn the loan into a fixed-rate one. A bank whose deposits reprice faster than its loans can use swaps to protect its net interest margin. Interest rate derivatives, the category to which swaps belong, made up 79 percent of OTC derivatives notional at end-June 2025, according to the BIS.
A swap's market value moves as rates move along the yield curve, so each side has a credit exposure to the other that grows or shrinks over time. Standard swaps between large institutions are now commonly cleared through a central counterparty and margined daily. For a payments firm earning interest on client balances, the same tool can fix income that would otherwise fall with short-term rates.
In practice
Paying fixed removes uncertainty about the rate, not the cost of being wrong. If rates fall, the fixed payer keeps paying the higher rate and shows a mark-to-market loss that may have to be collateralised.
Example
A company has a US$50 million loan at SOFR plus 2 percent. It enters a swap on US$50 million in which it pays 4 percent fixed and receives SOFR. The SOFR it receives cancels the SOFR it pays the lender, leaving an all-in cost of 6 percent whatever SOFR does.
Learn more on Money Wiki
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Commonly confused with
| Term | How it differs |
|---|---|
| FX swap | An FX swap exchanges two currencies now and reverses the exchange later, with principal changing hands. An interest rate swap exchanges interest payments in one currency, and the principal is never exchanged. |
See also
- SOFRSOFR, the Secured Overnight Financing Rate, measures the cost of borrowing US dollars overnight against Treasury securities as collateral. Published daily by the New York Fed, it replaced US dollar LIBOR as the main reference rate for dollar loans and derivatives.
- Notional AmountThe notional amount is the reference size of a derivative contract, the face value on which its payments are calculated. In many derivatives it is never exchanged, and it is not the amount at risk, which is usually a small fraction of it.
- DerivativeA derivative is a contract whose value comes from the price, rate or event it references, called the underlying. It lets parties take on or shed exposure to that underlying without buying or selling the underlying itself.
- Central CounterpartyA central counterparty is a clearing house that steps between the two sides of a trade, becoming the buyer to every seller and the seller to every buyer, so that each party's exposure is to the CCP rather than to the other.
- Yield CurveThe yield curve plots the interest rates on bonds of the same credit quality across different maturities, usually government bonds from one month to thirty years. Its shape shows what markets expect for interest rates, inflation and growth.
- Net Interest MarginNet interest margin is a bank's interest income minus its interest expense, expressed as a percentage of its interest-earning assets. It measures how much a lender earns on the gap between what it charges borrowers and what it pays for funds.