Options & derivatives
Swap
An agreement between two parties to exchange one set of cash flows for another.
How it works
The commonest is an interest-rate swap, exchanging fixed payments for floating ones. Total return swaps exchange the return on an asset for a financing rate.
Swaps are mostly traded between institutions rather than on exchange, which is why counterparty risk matters and why central clearing was extended to them after 2008.
Related terms
- DerivativeA contract whose value comes from the price of something else.
- Counterparty riskThe risk that the other side of a contract fails to do what it promised.
- Synthetic ETFAn ETF that uses a swap to deliver an index return rather than holding the constituents.
- Interest-rate riskThe risk that rising interest rates reduce the market value of bonds you already hold.
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