The purpose of an interest rate swap is to reduce the interest rate risk, and it also allows the company to benefit from any rate fluctuations.
From floating to fixed
A long-term interest rate swap is of interest to a company that has loans with a floating rate, but due to a fear of rising interest rates wishes to tie the interest rate for the remaining term of the loan. By entering into an interest rate swap with the bank, an agreement is made whereby the bank pays the loan’s floating interest rate (STIBOR based market rate, excluding margin) against the client paying a fixed rate to the bank (swap rate).
From fixed to floating
An interest rate swap can also be relevant in situations where a company has access to fixed rate loans in the bond market, but is interested in a loan with a floating rate. Choosing an interest rate swap with the bank ensures the company a floating rate, while the bank pays the fixed rate on the company’s bond loan.