Interest rate swap (IRS) is a bilateral agreement to exchange interest payments at agreed periodicity for a specified period of time by converting a variable interest rate (e.g. Euribor 3m, Euribor 6m) into a fixed one or vice versa. Usually, one party pays a fixed interest rate, whereas the other pays a variable interest rate (e.g. Euribor 3m, Euribor 6m).
Avoid future fluctuations
- Effective way to convert a variable interest rate into a fixed one
- Possibility of planning interest expenses and cash flows in the long-term
- Minimum transaction amount EUR 1 million
Related Risks
The major risk is related to market interest rate changes because both parties must perform their obligations assumed under the transaction.
For instance, if market interest rates decrease, in case of an interest rate swap a fixed-rate payer would incur a loss, whereas if market interest rates increase a recipient would incur a loss.
These transactions are concluded over-the-counter; therefore, under certain circumstances in the market, the market value of fixed-term or interest rate swaps may be subject to higher volatility. For this reason, where the concluded swap is sold on the market, or where an offsetting transaction is used for closure, the market value of the transaction may be unfavourable to the party to the transaction.
Examples
Let us suppose that you concluded an interest rate swap on 1 January 2021
| Basic terms | |
| Transaction amount | EUR 1 million |
| Expiration time | 5 years |
| Fixed interest rate | 0.6% |
| Variable interest rate | EURIBOR 6M |
| Periodicity of exchange of interest payments | Every 6 months |
On 1 July 2021, EURIBOR 6M stands at 0.50%.
| Amount due to you from the bank | 1,000,000 x 0.50 % x 180 / 360 = EUR 2,500 |
| Amount due to the bank from you | 1,000,000 x 0.60 % x 180 / 360 = EUR 3,000 |
| Final result | You pay EUR 500 to the bank |
On 1 January 2022, EURIBOR 6M reaches 0.80%.
| Amount due to you from the bank | 1,000,000 x 0.80 % x 180 / 360 = EUR 4,000 |
| Amount due to the bank from you | 1,000,000 x 0.60 % x 180 / 360 = EUR 3,000 |
| Final result | The bank pays EUR 1,000 to you |
The same principle applies to the calculation of other payments until the completion of the transaction, i.e. until 1 January 2026.
Contact us for more information
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Markets in Financial Instruments Directive
The Markets in Financial Instruments Directive (MIFID) regulates the rendering of financial investment services and has been effective in the European Union and the European Economic Community (EEC) since 2007. The requirements of MiFID are aimed to provide additional protection to investors and promote the transparency of financial markets in terms of transactions in financial instruments.
After 3rd January 2018, new rules of the Markets in Financial Instruments Directive 2014/65/EU (MiFID II) came into force and affect each investor who engages in transactions in financial instruments.
After 3rd January 2018, new rules of the Markets in Financial Instruments Directive 2014/65/EU (MiFID II) came into force and affect each investor who engages in transactions in financial instruments.
Please note that the data, examples, and information on derivative financial instruments provided herein is for informational purposes only. This information has been prepared without consideration or regard of your knowledge or experience related to specific financial instruments and without having any information about your investment objectives or financial capacity to assume risks related to the conclusion of the transaction that meets your investment objectives; therefore, it cannot be construed as a personal investment recommendation, advice on trading in derivative financial instruments or investment research, order or invitation to buy or sell specific financial instruments and may not constitute any basis or part of any subsequent transaction. Further information on risk factors is available in the publications “Description of Risks Related to Financial Instruments” (PDF, LT) and “Derivatives instruments description” (PDF).
