- Swap (finance)
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Swaps (horse) .In finance, a

**swap**is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the "legs" of the swap.The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be used to create unfunded exposures to an underlying asset, since counterparties can earn the profit or loss from movements in price without having to post the notional amount in cash or collateral.

Swaps can be used to hedge certain risks such as

interest rate risk , or to speculate on changes in the underlying prices.**tructure**A swap is an agreement between two parties to exchange future cash flows according to a prearranged formula. They can be regarded as portfolios of forward contracts. The streams of cash flows are called “legs” of the swap. Usually at the time when contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as interest rate, foreign exchange rate, equity price or commodity price.

Most swaps are traded Over The Counter (OTC), "tailor-made" for the counterparties. Some types of swaps are also exchanged on futures markets, for instance Chicago Mercantile Exchange Holdings Inc., the largest U.S. futures market, the Chicago Board Options Exchange and Frankfurt-based Eurex AG. David Swensen, a Yale Ph.D. at Salomon Brothers, engineered the first swap transaction according to "" by

Roger Lowenstein .The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps.

The

Bank for International Settlements (BIS) publishes statistics on thenotional amount s outstanding in the OTCDerivatives market . At the end of 2006, this was USD 415.2 trillion, more than 8.5 times the 2006 gross world product. However, since thecash flow generated by a swap is equal to an interest rate times that notional amount, the cash flow generated from swaps is a substantial fraction of but much less than the gross world product -- which is also a cash-flow measure. The majority of this (USD 292.0 trillion) was due tointerest rate swap s. These split by currency as::"Source: "The Global OTC Derivatives Market at end-December 2004", BIS", [*http://www.bis.org/publ/otc_hy0505.htm*] , "OTC Derivatives Market Activity in the Second Half of 2006", BIS", [*http://www.bis.org/publ/otc_hy0705.pdf*] " Usually, at least one of the legs has a rate that is "variable". It can depend on a reference rate, the total return of a swap, an economic statistic, etc. The most important criterion is that it comes from an independent third party, to avoid anyconflict of interest . For instance,LIBOR is published by theBritish Bankers Association , an independent trade body.**Example**Take the case of a plain vanilla "fixed-to-floating"

interest rate swap . Here party A makes periodic interest payments to party B based on a "variable" interest rate ofLIBOR +50basis point s.Party B in turn makes periodic interest payments based on a fixed rate of 3%. The payments are calculated over the "notional" amount. The first rate is called "variable", because it is reset at the beginning of each interest calculation period to the then current

reference rate , such asLIBOR .**Total return swap**A

**total return swap**is a swap in which party A pays the "total return" of anasset , and party B makes periodic interest payments. The "total return" is the capital gain or loss, plus any interest or dividend payments. Note that if the total return is negative, then party A receives this amount from party B. The parties have exposure to the return of the underlying stock or index, without having to hold theunderlying assets. The profit or loss of party B is the same for him as actually owning the underlying asset.Total return swap (also known as total rate of return swap, or

TRORS ) is a contract in which one party receives interest payments on a reference asset plus any capital gains and losses over the payment period, while the other receives a specified fixed or floating cash flow unrelated to the credit worthiness of the reference asset, especially where the payments are based on the same notional amount. The reference asset may be any asset, index, or basket of assets.The

TRORS , then, allows one party to derive the economic benefit of owning an asset without putting that asset on its balance sheet, and allows the other (which does retain that asset on its balance sheet) to buy protection against a potential decline in its value.The essential difference between a TRORS and a

credit default swap is that the latter provides protection not against loss in asset value but against specific credit events. In a sense, a TRORS isn’t a credit derivative at all, in the sense that a credit default swap is. ATRORS is funding-cost arbitrage.**Equity Swap**An

**equity swap**is a special type of total return swap, where the underlying asset is a stock, a basket of stocks, or a stock index. Compared to actually owning the stock, in this case you do not have to pay anything up front, but you do not have any voting or other rights that stock holders do have.**Valuation**The value of a swap is the

net present value (NPV) of all future cash flows. Initially, the terms of a swap contract are such that the NPV of all futurecash flow s is equal to zero.For example, consider a plain vanilla fixed-to-floating interest rate swap where Party A pays a fixed rate, and Party B pays a floating rate. In such an agreement the "fixed rate" would be such that the present value of future fixed rate payments by Party A are equal to the present value of the "expected" future floating rate payments (i.e. the NPV is zero). Where this is not the case, an

Arbitrage ur, C, could:

# assume the position with the "lower" present value of payments, and borrow funds equal to this present value

# meet the cash flow obligations on the position by using the borrowed funds, and receive the corresponding payments - which have a higher present value

# use the received payments to repay the debt on the borrowed funds

# pocket the difference - where the difference between the present value of the loan and the present value of the inflows is the arbitrage profit."See: Rational pricing;Arbitrage "**Variations**Variations of swaps include cross currency swaps, amortizing swaps and so on.

**Interest Rate Swaps**The most common type of swaps is a “plain Vanilla” interest rate swap. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this exchange is to take benefit from comparative advantage. Some companies may have comparative advantage in fixed rate markets while other companies have a comparative advantage in floating rate markets. When companies want to borrow they look for cheap borrowing i.e. from the market where they have comparative advantage. However this may lead to a company borrowing fixed when it wants floating or borrowing floating when it wants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa.

**London Inter Bank Offer Rate (LIBOR)**LIBOR is the rate of interest offered by banks on deposit from other banks in the

eurocurrency market. One month LIBOR is the rate offered for 1-month deposits, 3-month LIBOR for three months deposits, etc. LIBOR rates are determined by trading between banks and change continuously as economic conditions change. Just prime rate of interest quoted in the domestic market, LIBOR is a reference rate of interest in the International Market.**Currency Swaps**The Currency Swap involves exchanging principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency.Just like interest rate swaps, the currency swaps also are motivated by comparative advantage.

**Options**An option on a swap is called a

.swaption **References***Financial Institutions Management, Saunders A. & Cornett M., McGraw-Hill Irwin 2006

**ee also***

Credit default swap

*Cross currency swap

*Equity swap

*Foreign exchange swap

*Constant maturity swap

*Yield curve

*Variance swap

*Interest rate swap

*Total return swap **External links*** [

*http://www.quantnotes.com/fundamentals/swaps/index.htm swaps index*] , quantnotes.com

* [*http://www.swap-rates.com/ swaps-rates.com*] , Interest swap rates statistics online

* [*http://www.bis.org Bank for International Settlements*]

*Wikimedia Foundation.
2010.*

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**Swap (finance)**— Produits dérivés financiers Produits fermes Forwards (Contrat de gré à gré) Futures (Contrat à terme) Swaps (Échange financier) Produits optionnels Options et Warrants Credit default swap (couvertures de défaillance) … Wikipédia en Français**SWAP**— (finance) Le swap (de l anglais to swap : échanger) ou l échange financier (J.O. du 31 janvier 1990) est un produit dérivé financier. Il s agit d un contrat d échange de flux financiers entre deux parties, qui sont généralement des banques… … Wikipédia en Français**Swap (économie)**— Swap (finance) Le swap (de l anglais to swap : échanger) ou l échange financier (J.O. du 31 janvier 1990) est un produit dérivé financier. Il s agit d un contrat d échange de flux financiers entre deux parties, qui sont généralement des… … Wikipédia en Français**Swap de volatilite**— Swap de volatilité Un swap de volatilité (resp. de variance) est un produit dérivé dont le payoff est N(σR − Kvol) (resp. ), où σR est la volatilité réalisée sur la période du swap. On peut s en servir pour spéculer sur le niveau futur de la… … Wikipédia en Français**swap**— A contract to buy and sell currencies with spot ( cash and carry) or forward contracts. The contract provides for the buying and selling to occur at different times; thus, each party acquires a currency it needs for a predetermined period of time … Financial and business terms**Swap**— An arrangement whereby two companies lend to each other on different terms, e.g. in different currencies, and/or at different interest rates, fixed or floating. The New York Times Financial Glossary * * * ▪ I. swap swap 1 [swɒp ǁ swɑːp] also swop … Financial and business terms**Swap de volatilité**— Un swap de volatilité (resp. de variance) est un produit dérivé dont le payoff est N(σR − Kvol) (resp. ), où σR est la volatilité réalisée sur la période du swap. On peut s en servir pour spéculer sur le niveau futur de la volatilité d un cours… … Wikipédia en Français**Swap**— A swap is the barter of one thing for another. Swap may also refer to:* Swap (computer science), exchanging two variables in the memory of a computer * Swap (finance), a derivative in which two parties agree to exchange one stream of cash flows… … Wikipedia**Swap de taux d'interet**— Swap de taux d intérêt Les swaps de taux d intérêt (en anglais : Interest Rate Swaps ou IRS) sont un produit dérivé financier, dont l appellation officielle en français est « contrat d échange de taux d intérêt ». Voir les articles … Wikipédia en Français**swap**— [swäp, swôp] Informal vt., vi. swapped, swapping [ME swappen, to strike (prob. echoic): from the striking of hands on concluding a bargain] to exchange, trade, or barter n. 1. an exchange, trade, or barter 2. Finance a negotiated contract as… … English World dictionary