A financial agreement between two parties to exchange interest payments on a notional principal amount over a set period. In a typical IRS, one party pays a fixed interest rate, while the other pays a floating rate, often linked to a benchmark like LIBOR or SOFR. Importantly, the notional amount is not exchanged, it’s only used to calculate the interest payments. 

Interest rate swaps are commonly used by companies and financial institutions to manage interest rate exposure, convert between fixed and floating rate liabilities, or reduce funding costs. They are over-the-counter (OTC) instruments, allowing customization of terms such as tenor, reset frequency, and payment dates. 

For example, a company with a floating-rate loan may enter an IRS to pay a fixed rate and receive a floating rate, thereby locking in predictable interest expenses even if market rates rise. Conversely, another party may prefer variable payments to benefit from falling rates. 

Interest Rate Swaps are central to interest rate risk management, especially in corporate treasury, structured finance, and portfolio hedging. They are also widely used in derivatives markets, often cleared through central counterparties to reduce credit risk.