5: How Swap Rates are Calculated

How Swap Rates are Calculated, and Banks make a Profit: Banks set swap rates for their customers by acting as a middleman between the borrower and the wholesale swap market. In order to ‘lock in’ a profit margin for itself, the bank hedges the transaction by entering into an offsetting swap, simultaneous to the swap executed with the borrower. Fluctuations in LIBOR over time are hedged over time, while the bank’s profit comes from the difference between the rate the bank receives from the customer and the fixed rate it pays to the market.