What Is an Absolute Rate?

An absolute interest rate is a price quoted at an absolute rate rather than a benchmark rate. The benchmark interest rate is such as the London Interbank Offered Rate or the US Treasury Rate. For example, the absolute interest rate quote can be expressed as 10.375% instead of LIBOR + 0.75% ^[1] .

Absolute interest rate

Absolute interest rate refers to the total return realized by the two sides of the interest rate swap through the swap. It is expressed as a percentage, not a premium / discount of the benchmark interest rate. The absolute interest rate is the sum of fixed and floating rates. Interest rate swap refers to an agreement signed between two entities, stipulating that the two parties exchange interest payments on two separate loans at a series of points in time within a specified period. The principals of the two loans are the same, one of which bears interest at floating rates and the other of which bears interest at fixed rates. The fixed interest rate can be determined when the contract is signed, and the floating interest rate is usually based on floating interest rates on some authoritative international financial markets, such as LIBOR (London Interbank Offered Rate). Total swap income is also called absolute swap income.

Companies can use interest rate swaps to control or manage the risk of interest rate fluctuations. In interest rate swaps, the absolute interest rate is the sum of fixed and floating rates. For example, ABC Company borrowed a loan of RMB 1,000,000 from the borrower and paid a floating interest rate (assuming LIBOR + 2%). If the current LIBOR is 5%, ABC will need to pay 70,000 yuan in interest on this loan each time, and this amount will change as the LIBOR changes. XYZ also borrowed RMB 1,000,000 and agreed to pay interest at a fixed interest rate of 8%. Since the loan bears interest at a fixed rate, XYZ Company needs to pay the borrower 80,000 yuan in interest each time. Suppose ABC company wants to avoid interest rate fluctuations, and XZY company feels that they have paid too much interest on the loan (they may all think that interest rates will fall). Although they cannot end the loan agreement, they can exchange interest payments with each other through interest rate swaps. Assume that LIBOR is 2%, the fixed rate portion of the swap is 8%, and the absolute interest rate is the sum of the fixed and floating rates, which is 10%. In this case, the absolute interest rate is 8% + 5% = 13%. ^[1]