Tim Bennett explains how an interest rate swap works - and the implications for investors.
Entry from MoneyWeek's Financial glossary.
Swaps
The way a borrower can most easily raise money isn't always best suited to their needs. Imagine two firms need to raise money. Company A might easily be able to raise fixed-interest money, but what it really needs are floating rate funds. The reverse is true for Company B. The solution for them would be an interest rate swap. Company A issues its fixed-interest bond and Company B issues a floating-rate loan.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
They then agree to swap their interest payment liabilities, and so pay one another's interest and end up getting the money in the form they need it at a cheaper rate than if they had borrowed it direct. In practice, rather than finding a direct counterparty for the swap, companies will arrange it with a bank that will either find the counterparty for them or act as counterparty itself. Currency swaps are where Company A wants dollars but can get better trading terms in euros, while the reverse is true for Company B, so they swap so that each ends up with what it needs. With many swaps, both interest payments and currencies are exchanged.
-
Why Chinese stocks are so far out of favourThere’s little appetite for Chinese stocks despite low valuations.
-
The 62 UK areas where you could be priced out of using your Lifetime ISASaving for your first home in Croydon, Ealing, Brent or any one of these other locations? You could be at risk of being priced out of using your Lifetime ISA
