Interest rate swaps are typically transacted by borrowers with floating rate loans, effectively converting the floating rate loans into fixed rate loans.
A swap combines an interest rate cap in the borrower’s favour with an interest rate floor adverse to the borrower. When the floating rate is higher than the swap rate, the borrower receives payments under the swap. The further that the floating rate exceeds the swap rate, the greater the payments received by the borrower.
When the floating rate is lower than the swap rate, the borrower makes payments under the swap. The further the floating rate falls below the swap rate, the greater the payments made by the borrower.
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