Course · Act II: Hedge the Book · Chapter 10
Interest rate swaps
How an interest rate swap trades fixed for floating on a notional, what SOFR is, why paying fixed has negative duration, and how banks use swaps to hedge bond portfolios.
Key terms
- Interest rate swap
- A contract to trade fixed-rate for floating-rate interest on a notional amount. Only the difference is paid.
- Notional
- The amount a swap’s interest is worked out on. It never changes hands.
- SOFR
- Secured Overnight Financing Rate: the cost of borrowing overnight against Treasuries. The floating rate in most dollar swaps.
- Pay fixed / receive fixed
- Paying fixed gains when rates rise, like being short a bond. Receiving fixed is like owning one.
“The Swap” is part of the full course: 6 puzzles on interest rate swaps. Gullwing and Osprey are fictional banks; the Treasury yields and Fed rates are real. Try this act’s free chapter, “Who Sets the Short End”, first.
“The Swap” is in Act II: Hedge the Book. 6 puzzles, unlimited retries.
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