What is an interest rate derivative (IRD)?
An IRD or interest rate swap is a derivative which is a contract
between 2 parties that agree to exchange interest payments between
each other based on fixed and floating interest rates. IRDs are
typically forward contracts where the specific term dates and
prices can be customised according to the arrrangement. They are
predominantly used by market participants (which can include the
likes of traders, banks, borrowers and corporate treasurers) to
hedge their positions or speculate market activity. However, they
come with inherent market risk and exposure risk.
The most commonly used IRD is a 'plain vanilla' swap
where fixed rate payments are exchanged for floating (or variable)
rate payments based on the overnight benchmark financing rate such
as SOFR (i.e. the benchmark interest rate for
dollar-denominated derivatives and loans which replaced) or ESTER (Euro Short-Term Rate).
