What financial instrument is used by investors to hedge against fluctuations in interest rates?

Interest rate swaps are financial instruments specifically designed to help investors and institutions manage and hedge against fluctuations in interest rates. In a typical interest rate swap agreement, two parties exchange cash flows based on different interest rate structures, usually one fixed and one variable. This allows the parties to take advantage of favorable interest rate changes or to stabilize their cash flows by shifting the risk of interest rate movements.

For example, if an organization holds a variable-rate loan but wishes to convert it to a fixed-rate loan to avoid rising interest payments, it can enter into an interest rate swap to receive fixed payments while paying variable interest. This swap mechanism effectively mitigates risk associated with interest rate volatility, making it a powerful tool for financial management.

Other instruments, like futures contracts or options contracts, can also relate to interest rates but are not tailored specifically for hedging against interest rate fluctuations in the same way that swaps are. Futures and options may involve speculating or guaranteeing a price on financial instruments or commodities, whereas forward contracts are agreements to buy or sell an asset at a future date for a predetermined price, also lacking the specific focus on interest rates that swaps offer.