Explain the mechanics of an interest rate swap from initiation to maturity, including cash flows and valuation.
A core Corporate Treasury interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
An interest rate swap exchanges fixed-rate payments for floating-rate payments based on a notional principal. At initiation, no upfront cash changes hands if the swap is at-market. Periodically, the fixed leg pays a set rate on the notional, while the floating leg pays a reference rate (e.g., SOFR) plus a spread. Net settlement occurs between parties. The swap's value is the present value of expected future cash flows, which changes with interest rates. At maturity, the final exchange is made and the swap terminates.
WHAT INTERVIEWERS LISTEN FOR
- ✓Describes fixed vs. floating leg payments
- ✓Explains net settlement and no upfront cash for at-market swaps
- ✓Mentions valuation as PV of future cash flows
COMMON MISTAKES
- ✗Thinks notional is exchanged
- ✗Ignores periodic settlement
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