An interest rate swap is an agreement where two parties trade interest payment obligations. One party pays a fixed rate; the other pays a floating rate (tied to a benchmark like SOFR or LIBOR). No principal changes hands — only the interest payments are swapped.
Example: Company A has a floating-rate loan at SOFR + 2% and worries rates will rise. Company B has a fixed-rate loan at 5% and thinks rates will fall. They swap: A pays B's fixed 5%, B pays A's floating rate. Both get the rate structure they prefer.
The interest rate swap market is the largest derivatives market in the world — over $500 trillion in notional value. Banks, corporations, and governments use swaps to manage interest rate risk. The 2022-2024 rate hiking cycle made swaps especially active as companies scrambled to lock in fixed rates before they rose further.