The exchange of a stream of floating interest payments in return for a stream of fixed interest payments. An interest rate swap consists of two legs, fixed rate and floating rate. The fixed rate leg payer pays a fixed rate (the Swap Rate) and receives a stream of floating payments. The floating leg payments are calculated at the prevailing market interest rate on that payment date, for example a floating leg with a payment frequency of Quarterly would have payments calculated using the current 3 month deposit rate on each payment date.
Interest rate swaps are commonly used by both banks and corporates to convert their interest payments, for example a corporation which issues floating rate bonds may wish instead to pay a fixed rate to enable financial planning. The corporate entering a pay fixed/receive floating swap would in effect convert that debt to fixed rate.
The fixed leg of the swap is typically the only leg which is sensitive to changes in interest rates as it can be considered as a fixed rate bond, the offsetting floating leg is typically insensitive to changes in interest rates as the rate refixes regularly throughout the life of the swap.