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Swap

Definition

A swap is a type of derivative. It is a private transaction that closely resembles two forward contracts that involves a counterparty on each side of the transaction. There are cash flows that are exchanged by the two parties on pre-defined dates. Usually one party pays a fixed amount and the other party pays a variable amount. Swaps are used by companies and individuals to for hedging purposes or to gain exposure to different types of risks in order to profit from certain viewpoints.

Using the term Swap :

Mr. Ben Benson, CFO of company XYZ, enters a swap which bases its cash flows on a notional principal amount, which is not exchanged. Mr. Benson is paying fixed and receiving floating cash flows in order to hedge his cash flow liabilities.

Pay Special Attention To :

As notional is often not exchanged, swaps may be used to speculate. In the fixed income markets, there are credit default swaps which are effectively insurance contracts that do not require any reserves on behalf of the insurance writer. Many professionals cite the rise of these types of swaps (there are trillions of dollards in existence) as a player in the financial "crisis" of 2008-2009 as they served as leveraged positions with no reserves required on behalf of the investment banks that wrote them. These markets are now being more closely regulated, which in this case is likely a good thing.

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Related terms

derivative

'Swap' appears in these other terms:

Accreting Swap 

'Swap' appears in the definitions of these other terms:

Accreting Swap Counterparty Risk Currency Risk Forwards