How do interest rate swaps function?

Interest rate swaps function primarily by allowing two parties to exchange interest rate cash flows, typically involving one party paying a fixed rate and the other paying a floating rate. This financial derivative enables organizations to manage their interest rate exposure and associated cash flow risks. By entering into an interest rate swap, a company can effectively adapt its interest payment obligations to better align with its financial strategy, which may involve speculation on future interest rate movements or hedging against fluctuations.

Interest rate swaps are commonly used in various financial markets and can be beneficial for entities looking to lower borrowing costs or modify their interest rate profile without having to refinance their debt. As a result, they play a crucial role in corporate finance and risk management strategies, illustrating their function in enhancing financial flexibility.