What Is A Swap?

Characteristics of a swap

There is a mystique which surrounds swap contracts due to lack of knowledge or available information. By explaining the basics of swaps, including how they work and what their purpose is, I hope this will help to clarify them.

A swap is an agreement between two parties to exchange a series of future cash flows. Swaps are financial instruments that fall under the general umbrella of financial derivatives. Other types of derivatives are forward agreements, futures and options (calls and puts). Most swaps are over-the-counter instruments; this means that they are customised to the requirements of the counterparties to the swap. A swap can be viewed as the exchange of one loan for another. A standard loan will have interest and principal repayment terms and the interest is based on either a fixed or floating rate. The three most common types of swaps are interest rate swaps, currency swaps and equity swaps.