A swaption is an option on an interest rate swap. The buyer of a swaption has the right, but not an obligation, to enter into an interest rate swap with predefined terms at the expiration of the option. In exchange for a premium payment, the buyer can lock in either a fixed or variable interest rate. Thus, if the buyer believes that interest rates will rise, he can enter into a swaption agreement, which he can later convert into an interest rate swap if interest rates do indeed go up.

A swaption can be a risky endeavor for the swaption seller, since the seller is taking on a potentially substantial risk in exchange for a premium.

Swaptions are primarily entered into by larger business enterprises, such as banks, hedge funds, and corporations.

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