Swaps

An interest-rate swap is a transaction between two purported counterparties wherein fixed and floating interest-rate payments on a notional amount of principal are traded over a predetermined term. One counterparty pays interest at a fixed rate and gets interest at a floating rate (normally three-month Libor). Different pays interest at the floating rate and gets the fixed-rate payment. A swap can give both counterparties a lower cost of money than could be gotten from investors, to some degree initially.
On the off chance that interest rates in this manner rise, pushing floating rates higher, the fixed-rate payer acquires extra savings to the detriment of the floating-rate payer. Alternately, assuming rates move lower, the floating-rate payer acquires extra savings to the detriment of the fixed-rate payer.
A swaps dealer is regularly one of the counterparties. Swaps dealers hedge their risk by going into certain transactions where they pay a fixed rate and others where they pay a floating rate. The dealers profit from the difference between the fixed rate they will pay and the fixed rate they demand.
A swap spread is the difference between the fixed interest rate and the yield of the Treasury security of a similar maturity as the term of the swap. For instance, in the event that the going rate for a 10-year Libor swap is 4% and the 10-year Treasury note is yielding 3%, the 10-year swap spread is 100 basis points. Swap spreads correspond closely with credit spreads. They reflect perceived risk that swap counterparties will fail to make their payments.