Interest Rate Swap
Generally there are two ways of paying interest. The first is to have a fixed percentage rate which is due at a specific date in time. The second way is to have flexible amount of interest, due at some date in the future.
In the first case the amount payable is fixed – no matter what happens over time. This offers a great level for planning reliably. Although, in case of bad performance or cash shortage, the fixed amount can be a burden because the company may not be able to pay the fixed rate.
A flexible amount of interest, also called floating amount, reverses the situation. Thus, the level of planning reliably is lower and there is the possibility to pay less or more in certain times.
Swapping interest rates means that you change from one way of paying the interest rate to the other way. Fixed for flexible or the other around.
Swapping rates requires the permission of the other party, to whom one is paying the interest. As the transaction is a so called over the counter (OTC) transaction, where at least two parties are involved, the condition of the swap can differ from contract to contract.
Swaps are often used when a company can borrow money easily at one type of interest rate but prefers a different type.
Whether a swap is possible or not is usually determined in the contract. In some cases the lender charges extra fees in order to give permission for the swap.
For any question regarding interest rate swaps, do not hesitate to contact us.
WHU-Finance Society e.V.