Interest rate swaps are derivative instruments commonly used by sophisticated investors to allow cash flows on interest earning securities or loans to be exchanged. One of the most common examples of an interest rate swap is when two parties have different terms on loan agreements (e.g. fixed vs. variable interest rates), and one party undertakes payments linked to short-term floating interest rates (such as LIBOR) in order to receive fixed payments. The counterparty to this transaction then undertakes the fixed payments. But how do these interest rate swaps work? Salman Khan of the Khan Academy explains.