Question

Explain interest rate swaps with diagrams.

Answer 1

Interest rate swap is a Portfolio of Forward contracts which involves an exchange of stream of interest rates based upon different Interest rates. These different interest rates can be floating or fixed.  

Example:
If person "A" wants to take a floating rate and B want to take Fixed rate.

But their following rates are:
A:
Floating rate: LIBOR+0.5%
Fixed rate: 5%

B:
Floating rate: LIBOR+ 1%
Fixed rate: 6.5%

If a bank is involved in interest rate swap and takes a commission of 0.5%

The. A&B can save 0.25% by use of interest rate swap.

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