An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a (usually notional) amount of money at a given interest rate.

Most of the exotic interest rate derivatives can be classified as having two payment legs: a funding leg and an exotic coupon leg. A funding leg usually consists of series of fixed coupons or floating coupons (LIBOR) plus fixed spread. An exotic coupon leg typically consists of a functional dependence on the past and current underlying indices (LIBOR, CMS rate, FX rate) and sometimes on its own past levels, as in Snowballs and TARNs. The payer of the exotic coupon leg usually has a right to cancel the deal on any of the coupon payment dates, resulting in the so-called Bermudan exercise feature. There may also be some range-accrual and knock-out features inherent in the exotic coupon definition.

These structures are popular for investors with customized cashflow needs or specific views on the interest rate movements (such as volatility movements or simple directional movements).

Modeling of interest rate derivatives (see Mathematical Finance) is usually done on a time-dependent multi-dimensional tree built for the underlying risk drivers, examples of which are domestic or foreign short rates and Forex rates.