How are interest rate swaps defined?

Interest rate swaps are defined as an exchange of one set of interest rate payments for another. In this financial instrument, two parties agree to swap interest rate cash flows, typically one party paying a fixed interest rate while the other pays a floating interest rate, although variations can exist. The primary purpose of this arrangement is to manage interest rate risk or to achieve a specific financial objective, such as lowering borrowing costs or improving cash flow stability.

In practical terms, such swaps are used by corporations, institutional investors, and other entities to adjust their interest rate exposure based on their predictions of future movements in interest rates. By entering into an interest rate swap, parties can better align their payment structures with their investment strategies or balance sheets. This swap does not involve exchange rates, equity trading, or direct currency management, which clarifies why the other options do not accurately describe the nature of interest rate swaps.