Interest Rate Risk Flashcards
(5 cards)
What is interest rate risk and why does it matter to firms?
Interest rate risk is the potential for fluctuations in interest rates to affect a firm’s borrowing costs or the value of its liabilities. It can reduce profitability and firm value.
What is an interest rate swap and how is it used?
An interest rate swap is a contract where two parties exchange interest payments, typically one fixed and one floating. It’s used to hedge against interest rate fluctuations.
What is the notional principal in a swap?
It’s the hypothetical amount used to calculate interest payments. It is never exchanged—only the interest difference is paid.
How does a firm use swaps to manage interest rate risk?
A firm can borrow at a floating rate and enter into a swap to pay fixed—thus locking in a predictable borrowing cost and hedging against rising interest rates.
