An interest rate swap
A)involves a swap buyer who agrees to make a number of variable-rate payments on periodic settlement dates.
B)involves a swap seller who agrees to make a number of fixed-rate payments on periodic settlement dates.
C)is effectively a succession of forward contracts on interest rates.
D)involves comparative advantage by the fixed-rate side of the swap, but not the variable-rate side.
E)eliminates credit risk.

Question

Quizplus · Accepted Answer

An interest rate swap involves two parties who agree to exchange interest rate payments over a set period of time. One party pays a fixed interest rate, while the other pays a variable interest rate. It is effectively a succession of forward contracts on interest rates, as the parties are agreeing to a series of future cash flows based on a pre-agreed interest rate. This allows both parties to manage their interest rate exposure and hedge against interest rate fluctuations. However, it does not eliminate credit risk, as both parties are still exposed to the credit risk of the other party.

An Interest Rate Swap