BASIS RATE SWAP

A type of swap in which two parties swap variable interest rates based on different money markets. This is usually done to limit interest-rate risk that a company faces as a result of having differing lending and borrowing rates.

For example, a company lends money to individuals at a variable rate that is tied to the London Interbank Offer (LIBOR) rate but they borrow money based on the Treasury Bill rate. This difference between the borrowing and lending rates (the spread) leads to interest-rate risk. By entering into a basis rate swap, where they exchange the T-Bill rate for the LIBOR rate, they eliminate this interest-rate risk.