What is Interest Rate Swap?
An interest rate swap is a derivative in which two parties agree to exchange interest payment streams on a notional principal — typically one stream at a fixed rate and the other at a floating rate. The principal itself is never exchanged. The instrument is used to convert fixed-rate debt to floating, or vice versa.
How It Works
- Notional principal is the reference amount; only interest is paid
- Most common: fixed-for-floating, settled net at each reset date
- Floating leg usually tied to a benchmark rate (SOFR, SAIBOR for Saudi deals)
- Counterparty risk now mostly managed via central clearing or collateral agreements
- Used by corporates to hedge funding cost and by investors to express rate views
Saudi Context
Saudi banks and corporates use SAR-denominated interest rate swaps based on SAIBOR (Saudi Interbank Offered Rate). After the global LIBOR transition, SAIBOR remains the local benchmark, supervised by SAMA. Sukuk issuers also sometimes pair fixed-rate sukuk with profit-rate swaps.
Example
A Saudi industrial company has SAR 1B of floating-rate (SAIBOR + 1.5%) debt. It worries rates will rise. It enters a swap: pays a fixed 5% to the bank, receives SAIBOR + 1.5%. The two floating legs net out, leaving the company with effective fixed-rate funding at 5% — protected against future rate hikes.