Absolute Rate (Interest Rate Swap) - Explained
What is the Absolute Rate on an Interest Rate Swap?
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Table of ContentsWhat is the Absolute Rate?How is the Absolute Rate Used?Academic Research on Absolute Rate
What is the Absolute Rate?
An absolute rate refers to the fixed portion of an interest rate swap that is expressed as a percentage without reference to the interest rate swaps premium or discount. An absolute rate is otherwise known as an absolute swap yield. An absolute rate is determined by calculating the basic rate of interest often called the LIBOR, and the fixed portion on the interest rate swap. The addition of both parts amounts to the absolute rate, this means that the absolute rate represents the total amount accumulated by the two parties involved in an interest rate swap. For example; in an interest rate swap, if the LIBOR is 5% and the fixed portion is 10%, then the absolute rate is 15%.
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How is the Absolute Rate Used?
Two parties are involved in an interest rate swap, it is a derivative agreement which entails that both parties agree to exchange interest rates based on the Principal amount. For instance, two parties can consent to the exchange of a fixed-rate interest payments for floating-rate interest payments using a benchmark reference rate. Vanilla swaps are the most common interest rate swaps, although, there are few others. However, absolute rate is realized by the addition of these two interest rates involved in the interest rate swap agreement. It is the addition of the LIBOR rate and the fixed-rate interest. It represents the percentage of yield or total yield accumulated by both parties in an interest rate swap.