As in a non-governmental fixed-rate market, the interest rate swap carries two major risks. Both of these risks are interest rate and credit risk. Credit risk in the market is also called counterparty risk. The interest rate risk is due to the fact that the anticipation of interest rates may not correspond to the real interest rate. A swap also carries a counterparty risk, which means that each party respects the contractual terms. The risk ratio for interest rate swaps peaked in 2008, when the parties refused to meet the interest rate swap commitment. At that time, it became important to create a clearing house to reduce counterparty risk. When high interest rates cost the World Bank dearly to borrow in the United States, the World Bank and IBM created the interest rate swap market in 1981. In the end, it borrowed U.S. dollars despite the high costs, but exchanged payments for foreign currency payments that IBM had on its debts (based on much lower interest rates).
Floating swaps afloat work a little differently, as both parties already have fluctuating interest rates. The swap exchanges either the variable rate type or the reference rate of the interest rate. This is a basic swap. Now look at an interest rate swap involving two investors. This example is that, like most non-sovereign fixed-rate investments, interest rate swaps involve two main risks: interest rate risk and credit risk, which is known in the swap market as counterparty risk. Managing the unpredictability of variable interest rates alone carries an inherent risk to both parties to the agreement. Let`s see what an interest rate swap contract might look like and how it plays in action. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should assess their ability to invest in the long term, especially in times of market recession. The variable interest rate can be set on LIBOR or LIBOR – a marker (known as Credit Spread). It is expressed in „LIBOR – x %,“ where „x“ is the credit spread.