Interest Rate Swap (IRS) is a popular financial derivative contract that allows two parties to exchange interest rate cash flows on a specified principal amount for a fixed period. The main purpose of this instrument is to manage exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would have been possible without the swap.

In a typical Interest Rate Swap agreement, one party pays a fixed interest rate while receiving a floating rate, usually benchmarked to a reference such as the Reserve Bank of Indiaís repo rate or MIBOR (Mumbai Interbank Offered Rate). The other party does the opposite ó paying the floating rate and receiving the fixed one. Importantly, the principal amount is not exchanged; only the net difference in interest payments is settled periodically.

These swaps are primarily used by banks, corporations, and institutional investors to hedge against interest rate risk. For example, a company with a variable-rate loan may enter into an IRS to pay a fixed rate, thus protecting itself from rising interest rates. Conversely, an investor expecting rates to decline may choose to receive floating payments to benefit from the expected drop.

The advantages of Interest Rate Swaps include better risk management, reduced borrowing costs, and improved cash flow predictability. However, participants must consider counterparty risk ó the possibility that the other party might default ó and the potential impact of changing market conditions on swap valuation.

In India, Interest Rate Swaps are regulated by the Reserve Bank of India (RBI) and traded in the over-the-counter (OTC) market, ensuring compliance with domestic and SEBI-aligned guidelines. Understanding these instruments is essential for financial professionals aiming to manage interest rate exposure efficiently and strategically.