What is the Swap Rate?
The swap rate is the fixed rate of a swap determined by the parties involved in the contract The swap rate is demanded by a receiver (i.e., the party that receives the fixed rate) from a payer (i.e., the party that pays the fixed rate) to be compensated for the uncertainty regarding fluctuations in the floating rate utilized in a swap. The swap rate can be found in either interest rate swaps or currency swaps. It also referred to as the reference rate, and is typically based on LIBOR for interest rate swaps.
Swap Rate in Interest Rate Swaps
The most commonly encountered design of interest rate swaps involves the exchange of a fixed interest rate for the floating interest rate. The floating interest rate is typically expressed as a value of a variable index such as LIBOR plus or minus a spread. In such a case, the fixed interest rate is referred to as the swap/reference rate.
In interest rate swaps, the swap/reference rate is used to determine the total value of the swap’s fixed leg, which must be equal to the total value of the floating leg of the swap. After the swap becomes effective, the fixed rate remains the same until the swap’s maturity while the floating interest rate is reset periodically at predetermined dates, based on the fluctuations of the index to which the rate is attached.
Swap Rate in Currency Swaps
Similar to interest rate swaps, currency swaps are a popular type of swap. Currency swaps may come in several forms. One of them is the fixed vs. floating rate currency swaps. In currency swaps, the swap/reference rate is referred to as the exchange rate associated with the fixed leg of a currency swap.
In currency swaps, the swap rate is primarily used as the exchange rate to convert the principal notional amounts set in different currencies. The principal notional amounts are specified prior to the start of the swap’s agreement. Like interest rate swaps, in currency swaps, the reference rate remains unchanged until the swap’s maturity.
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