Page 89 - PRIAA Glossary

INTEREST RATE FLOOR
An option (derivative) or floorlet on a specified reference rate. The buyer of the floor receives money if, on the maturity of any of the floorlets, the reference rate is below the agreed strike price of the floor.
INTEREST RATE FUTURES
A futures contract for securities and deposits whose prices are determined by reference to interest rates.
INTEREST RATE PARITY
The economic principle that helps establish forward FX rates for currency pairs, based upon the interest rate differential between the two currencies. According to no-arbitrage principles, an investor shouldn’t be able to make a risk-
free profit by converting an amount of cash into a foreign currency today and then investing in the foreign interest rate for a period of time. Today’s FX forward rates would be set to eliminate this risk-free opportunity.
INTEREST RATE STRADDLE
An interest rate transaction where the buyer pays a premium to the seller to buy a cap and a floor with identical details including the cap and floor rates. At set intervals, the
buyer receives from the seller the difference between the pre-agreed rate and the current floating rate. The buyer of
a straddle believes that the market is very volatile and is unsure as to the direction in which the rates will move.
INTEREST RATE SWAP (IRS)
A financial derivative in which each counterparty agrees to the exchange of a fixed /floating rate cash flow on a certain notional amount. This rate is typically multiplied by an accrual factor calculated with a day count fraction. In case both legs have the same currency, the notional amount is not exchanged; instead, it is used to define the cash flow to be exchanged. When the legs have different currencies, the notional amount is exchanged at the start and end of the swap term.
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