A combination of a fixed for floating interest rate swap with a binary option. The fixed rate leg for each payment period is set above or below the prevailing swap rate, depending on the level of a specific index at the reset date. In other words, the fixed rate leg of the swap is based on two fixed rates rather than one. However, the level of the floating rate (LIBOR) with respect to a predetermined trigger point determines which of the two fixed rates is payable or receivable. The trigger mechanism is typically established using an embedded binary option.
For example, consider a swap rate at 5%, the fixed rate for a semi-fixed swap might be 4.5% if the index is below an agreed trigger level as defined by the binary option; and, the rate might be 5.5% if the index is above the trigger level. That is, a floating rate borrower, expecting rates would move up in tandem with the implied forward curve, can receive LIBOR and pay a fixed rate below market in case LIBOR remains below the trigger rate, and the lower fixed rate is said, then, to be receivable. If LIBOR breaks out above the trigger rate, therefore, the higher fixed rate is payable.
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