Interest rate swaps are fantastic tools that can be used to match up your liability obligations and income
from assets. They allow you to make an agreement with another party to exchange floating and fixed
interest rates for a specific period of time. This can be very advantageous for your business.
There may come a time though, when you no longer wish to utilize the benefits of a rate swap. Perhaps
you don't need it anymore, or maybe it isn't profitable any longer. How do you exit the swap, when the
expiration date hasn't yet arrived? Do you have to wait and simply deal with consequences of a swap
that isn't working for you anymore? Or are there ways to exit the swap before predetermined end date?
How to Exit an Interest Rate Swap Before it Expires
If you truly need to exit out of your swaps before their termination date has arrived, there are four basic
ways you can do so.
Buy Out- When you are dealing with a futures contract or an option, you have the option to
terminate the contract early by paying the opposing party the market value. The same can be done for a
swap. However, with a swap, this is not necessarily automatic. If you wish to have a way to exit the swap
if you need to, make sure you include this option in your initial contract or obtain the counterparty's
consent in advance.
Offsetting Swaps- If you can't completely exit of the swap, consider beginning a second swap with
another party to offset the swap's consequences. For instance, if you received fixed swap rates with the
first party, you could enter into another agreement with someone else and receive floating rate swaps.
Sell the Swap- Every interest rate swap has a value, and if you need to terminate a swap early, you
can calculate this value on your rate swap spreadsheets and actually sell it to another party. In order to
so, however, you must obtain consent from the first party you were involved with. If they are unwilling
to let you sell it, you will have to use another rate swap strategy.
Swaptions- Swaptions are options that are available to a swap. By purchasing a swaption, you will
be allowed to set up, not actually enter into, an offsetting interest rate swap while you are still taking
part in the original swap. This is very similar to the second exit strategy mentioned above, however it
help you avoid much of the volatility in the market you may find when you are attempting to build a
new contract with another party.
Interest swaps can be very confusing for many individuals, but when used properly, this financial tool
can provide you with access to areas of the market that would otherwise be unavailable to you.
However, if you enter into a swap and decide later that it is not profitable or necessary for you, make
sure you understand how to exit out of your contract correctly by using these tips.