Which financial tool is typically used to mitigate interest rate risk?

Interest rate swaps are commonly used to manage and mitigate interest rate risk because they allow two parties to exchange interest rate cash flows. For instance, one party may agree to pay a fixed interest rate, while receiving a floating interest rate in return, or vice versa. This tool effectively allows companies to convert their exposure from fixed to floating rates or from floating to fixed rates, depending on their interest rate outlook and risk management strategy.

Organizations facing potential losses due to fluctuations in interest rates can thus stabilize their interest expenses or revenues by utilizing interest rate swaps. It provides them with the flexibility to align their interest rate exposure with their financial strategy and risk tolerance.

In contrast, equity investments are more associated with market risk than interest rate risk, making them unsuitable for this particular challenge. Commodity futures primarily deal with price risk associated with commodities and do not directly address changes in interest rates. Credit derivatives focus on managing credit risk rather than interest rate risk, which further distinguishes them from the function of interest rate swaps in mitigating interest rate-related issues.