A Derivative is a financial contract whose value depends on the value of one or more underlying assets such as foreign exchange rates, interest rates, commodities, and equities. It can be useful for hedging off the market risks using a derivative contract that can be tailored to the specific needs.
Interest Rate Swaps (IRS)
An IRS contract is where two parties agrees to exchange periodic interest payments over the contracted period. The interest payment is fixed on one leg and floating on the other. The amount of interest exchanged is based on some predetermined principal amount, which is referred to as the notional amount. On every payment date, the interest is settled on a net basis.
A client may use IRS is to hedge against future rise/fall in interest rates.
Interest Rate Swap Option (Swaption/Cap/Floor)
An Interest Rate Swaption gives you the right (but with no obligation), as a borrower of substantial funds, to enter into an Interest Rate Swap at an agreed interest rate on a set date in the future.
A Cap option represents an insurance against the rate of interest on a floating rate index used to price a liability rising above a certain predetermined level (strike).
Meanwhile, a Floor option provides a certain payout should the floating rate index goes below the predetermined strike rate.