Interest Rate Swaps And Forward Rate

An Interest Rate Swap (IRS) is a financial contract between two parties exchanging or swapping a stream of interest payments for a ‘notional principal’ amount on multiple occasions during a specified period. Such contracts generally involve exchange of ‘fixed to floating ‘or’ floating to floating rates of interest. Accordingly, on each payment date that occurs during the swap period-cash payments based on fixed/floating and floating rates, are made by the parties to one another.

A Forward Rate Agreement (FRA) is a financial contract between two parties to exchange interest payments for a ‘notional principal’ amount on settlement date, for a specified period from start date to maturity date. Accordingly, on the settlement date, cash payments based on contract (fixed) and the settlement rate, are made by the parties to one another. The settlement rate is the agreed bench-mark/ reference rate prevailing on the settlement date. Scheduled commercial banks (excluding Regional Rural Banks), primary dealers (PDs), Mutual funds and all-India financial institutions (FIs) are free to undertake FRAs/IRS as a product for their own balance sheet management or for market making. Banks/FIs/PDs can also offer these products to corporates for hedging their (corporates) own balance sheet exposures.