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Interest Rate Swap

A contractual agreement between two counterparties to make periodic payments on particular dates in the future for an agreed period of time based on a notional amount and there is no exchange of principal.

There are two types of cashflow payments called legs. A fixed rate payer always buys a swap and makes a series of fixed payments and at the outset of the swap, these cashflows are known. A floating rate payer, makes a series of payments that depend on the future level of interest rates (a quoted index like LIBOR for example) and at the outset of the swap, most or all of these cashflows are not known. In general, a swap agreement stipulates all of the conditions and definitions required to administer the swap including the notional principal amount, fixed coupon, accrual methods, day count methods, effective date, terminating date, cash flow frequency, compounding frequency, and basis for the floating index.

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