A derivative that involves the exchange of a fixed rate of interest on a certain notional amount for a floating rate of interest on the same notional amount. For example, an interest rate swap entitles an institution to receive 6-month LIBOR rate and pay a fixed rate of 6% per year every six months for a period of 4 years on a notional principal of $200 million. This kind of swaps is typically used to convert a liability from fixed rate to floating rate or vice versa. It can also be used to convert an investment from fixed rate to floating rate or vice versa.
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