What Is Meant by an 'Interest Rate Swap'? Illustrate Your

question 8

Essay

What is meant by an 'interest rate swap'? Illustrate your answer with a simple example of how such a swap operates and how it would affect the parties concerned.Why might businesses engage in an interest rate swap?

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Definitions:

Full Diversification

The process of spreading investments across various assets to reduce exposure to risk from any single asset.

Nonsystematic Risk

The risk associated with an individual investment or a small group of investments, which can be mitigated through diversification.

Treynor-Black Model

An optimization tool used by portfolio managers to balance the trade-off between risk and return by combining actively selected securities with a passively managed market portfolio.

Nonsystematic Risk

The risk associated with a specific issuer of a security, industry, or sector, which can be mitigated through diversification.