Interest Rate Swaps

Managing interest rate risk can make or break the success of a project. Derivative Logic knows how to design hedging strategies that give clients the greatest financing flexibility at a low cost. We provide unbiased analysis and a menu of hedging choices so borrowers can make informed decisions. The primary hedging option banks offer is a vanilla interest rate swap.

Swaps are the most commonly used hedging instruments typically offered by banks. They work best when used to hedge long-term financings of five years or more. Whether your interest rate exposure lies with the movement of LIBOR, SIFMA, SOFR, or Prime, a swap is a separate contract from the loan and confers significant hedge customization outside the parameters of the financing.

What Is An Interest Rate Swap?

A vanilla interest rate swap is a contract to exchange cash flows for a period of time, based upon a principal amount where one cash flow is calculated with a floating interest rate and the other is calculated with a fixed interest rate index.

Your individual loan provides the template to match

The floating rate index typically used is LIBOR (1- or 3-month), which will be replaced by SOFR soon, but swaps can also use Prime, SIFMA (tax-exempt rate) and other floating rates

Swaps create a similar result to a fixed rate loan for borrowers, with a two-way make-whole provision.

Vanilla Interest Rate Swap

Swap Mechanics – Two Important Pieces

The Monthly Settlement

  • Net Exchange of Interest Cash Flows
  • Difference between fixed and floating rate is paid
  • With a floating debt payment and this settlement, the synthetic fixed rate is achieved each period

The Mark-to-Market

  • Positive or negative paper value change based on market movement
  • Trends to zero as contract moves towards maturity
  • Equal to the expected sum of all remaining periodic settlements

When market rates shift, the value of a swap shifts as the expectations for future floating rates change. This value is an unrealized gain or loss unless the contract is terminated by the borrower. Each swap termination valuation is deal-specific and market factors at termination.

We Can Help

Derivative Logic helps clients execute swaps that match their risk profiles at the right price. We help clients manage and terminate interest rate swaps as necessary.
Please contact us to learn more or help you review your swap portfolio.

Call Derivative Logic Today at (415) 510-2100