When you are hoping for return on investment one of the surest ways to get that return is through investment in the debt of a nation. As a rule nations are not going to stiff you on your contributions to their debt; even if the spending outweighs what they are taking in. This is one of the reasons the situation in Greece is so worrisome. One way which all big companies and of course nations make money is by borrowing money against their future inflows of their income.
A company like Apple; if they had any interest or need in borrowing money; could borrow that money at a really good interest rate. This is because of the saturation of the Apple products and because of their explosive growth in recent years which does not seem to be slowing down in any measurable way. Apple makes a lot of money (A) and they have an interest in borrowing more money (B). The favorable interest rate they would have to pay on this money (C) is the end result of this equation (A/B=C).
Of course it’s not quite as simple as that; the length of the terms of the loan and what it is they want to use the money for (another money making avenue is likely to be viewed favorably) are all factors which go into the interest rates.
World nations have to worry about the prevailing world interest rate. One of the most common metrics is the LIBOR (London Interbank Offered Rate). LIBOR rates are decided on a daily basis and people are always hedging their bets on which way the LIBOR will go.
As a result of all of this, in 1981 a mechanism known as interest rate swaps took effect.
The World Bank and IBM had a problem in 1981. During that time interest rates in the United States were very high; the World Bank needed to borrow money but at a lower rate. IBM had debt to pay in Swiss francs and deutsche marks. The interest rate in Switzerland was far less than the US interest rate. So IBM and the World Bank worked out an arrangement where the World Bank borrowed US dollars and they “swapped” the dollar debt to IBM for IBM’s Swiss franc and deutsche mark debt.
As we all know when money is borrowed it is done so at a fixed rate or at an adjustable rate. Adjustable rates are going to move around the fixed rate note; sometimes higher, sometimes lower. When one entity, holding fixed rate obligations, believes that the interest rates for the adjustable rate debt is going to go down, then they would obviously want to hold fixed rate interest. The same is true for those holding adjustable rate notes as they may think that their interest rates are going to go up; why would they want to hold onto paper which is static when they could be earning more?
The game of interest rate swaps is one which a lot of bodies are interested in. The money held in interest rate swap obligations is in the trillions of dollars. For big companies, for deficit positive nations, for retirees, for trust fund babies, for the independently wealthy; the relative calm of the interest rate swap game is a welcome addition to their portfolio.
Of course to make any substantive amount in the interest rate swap market you have to have large sums of money invested. The interest rate returns are very narrow when compared against the rate of inflation. Still, having an avenue like interest rate swaps makes the choppy world markets a lot less of an imposition for many investors.
Sources:
http://www.reuters.com/article/2011/12/12/greece-idUSL6E7NC2WG20111212
http://www.investopedia.com/terms/i/interestrateswap.asp#axzz1ftKmH9GY