Index Amortizing Swap (IAS)
What Is an Index Amortizing Swap (IAS)?
An index amortizing swap (IAS), otherwise called an amortizing interest rate swap, is a type of interest rate swap agreement in which the principal amount is continuously reduced over the life of the swap agreement. It is something contrary to a Accreting Principal Swap, in which the notional principal increases.
Commonly, the reduction in the principal value is tied to a reference interest rate, like the London Interbank Offered Rate (LIBOR).
Understanding an Index Amortizing Swap (IAS)
Like any interest rate swap, IASs are over-the-counter (OTC) derivative contracts between two gatherings. One party wishes to receive a series of cash flows in view of a fixed rate of interest, while the other party wishes to receive cash flows in light of a floating rate of interest.
The difference between an IAS and a standard interest rate swap is that, in an IAS, the principal balance on which the interest payments are calculated can diminish over the life of the agreement. Normally, IASs will be indexed to LIBOR. In this situation, the principal will be reduced all the more quickly when LIBOR declines, and less quickly when LIBOR rises.
Special Considerations
By convention, most IAS agreements utilize a starting notional principal value of $100 million, with a maturity period of five years and an initial lock-out period of two years. This means that the principal balance would just start declining as of year three. Of course, since IAS agreements are OTC contracts, the specific terms can differ in light of the requirements of the gatherings in question.
Noticing that "amortization" is utilized contrastingly in this setting than in its typical utilization in finance is important." Here, amortization doesn't allude to the course of continuously paying off principal through a series of payments. All things considered, it alludes to a direct reduction of the notional principal amount that forms the basis for interest payments.
Exciting ride Swaps
Some interest rate swaps permit the notional principal amount to either diminish or increase in light of changes in a reference interest rate. These sorts of interest rate swaps are informally known as "exciting ride swaps."
Certifiable Example of an IAS
Emma is a institutional investor who chooses to go into an OTC IAS agreement. Under the terms of this agreement, Emma consents to pay her counterparty a series of cash flows in view of a fixed rate of interest. In exchange, her counterparty consents to pay her cash flows in view of a floating rate of interest, tied to LIBOR.
The notional principal for the IAS is set at $100 million, with an initial lock-out period of two years and a five-year term. Beginning in year three, the principal balance will reduce all the more quickly assuming the reference rate, LIBOR, declines. Then again, it will decline all the more leisurely assuming LIBOR rises.
Likewise with standard interest rate swap agreements, there is no initial exchange of principal. All things being equal, the two gatherings swap net cash flows periodically over the lifetime of the contract, contingent upon how interest rates advance.
Features
- An index amortizing swap is a type of over-the-counter (OTC) derivative contract.
- It is like an interest rate swap agreement, in that it includes the exchange of cash flows in light of fixed and variable rates of interest.
- Not at all like standard interest rate swaps, IAS agreements include a notional principal balance that declines over time. The rate of decline is linked to a reference interest rate, most ordinarily LIBOR.
