What are the most common types of interest rate swaps used in risk management?

1 Plain vanilla swaps

Plain vanilla swaps are the simplest and most popular form of interest rate swaps. In a plain vanilla swap, one party pays a fixed interest rate and receives a variable interest rate (usually based on a benchmark like LIBOR or EURIBOR) from the other party. The fixed rate is determined at the start of the swap and remains constant throughout the duration of the contract. The variable rate is reset periodically according to the agreed frequency and index. Plain vanilla swaps are useful for borrowers who want to lock in a fixed interest rate and avoid the uncertainty of variable rates, or for lenders who want to benefit from potential increases in variable rates.

2 Basis swaps

Basis swaps are a variation of plain vanilla swaps where both parties exchange variable interest rates, but based on different indices or currencies. For example, one party may pay a variable rate based on LIBOR and receive a variable rate based on EURIBOR, or vice versa. Basis swaps are useful for parties who want to hedge against the risk of divergence between different interest rate markets, or for arbitrageurs who want to exploit the differences in interest rate expectations.

3 Zero-coupon swaps

Zero-coupon swaps are a type of interest rate swaps where only one party makes a single payment at the end of the swap, while the other party makes no payment at all. The payment is calculated as the present value of the difference between the fixed and variable interest rates multiplied by the principal amount. Zero-coupon swaps are useful for parties who want to reduce their upfront cash flow requirements, or for speculators who want to bet on the direction of interest rate movements.

4 Amortizing swaps

Amortizing swaps are a type of interest rate swaps where the principal amount decreases over time according to a predetermined schedule. As a result, the interest payments also decrease over time. Amortizing swaps are useful for parties who want to match their swap payments with their amortizing debt obligations, or for parties who want to reduce their exposure to interest rate risk as the swap matures.

6 Deferred swaps

Deferred swaps are a type of interest rate swaps where the interest payments start after a certain period of time, rather than at the beginning of the swap. The deferred period can be fixed or variable, depending on the terms of the contract. Deferred swaps are useful for parties who want to delay their swap payments until a future date, or for parties who want to hedge against future interest rate changes.

7 Here’s what else to consider

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