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How does a financial institution reduce interest rate risk by using a swap?              

How does a financial institution reduce interest rate risk by using a swap?              

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Answer #1

Financial institutions face huge financial risk because of which they cannot he certain about their income. These institutions invest into instuments that pay an interest rate based on the market.

As the interest rates keep fluctuating, financial institutions have a risk of fluctuating interest rates. In this situation, they can use a swap transaction to reduce the risk of interest rates.

In a swap, the financial institution pays the fluctuating market interest rate and in return receives a fixed rate of interest. In this way, the institution will be able to reduce the fluctuation of interest rates and the risk associated with it.

Let me know in the comment section in case of any doubt.

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