Derivative contract to exchange flows of payments over a predetermined length of time.
There are many types of swaps: interest rate swap, currency swap, credit default swap, commodity swap (which fixes the price of a commodity over a certain period of time), real-estate swap, and equity swap.
Swaps are risky operations because they are tailored on customers needs, they are not standardised, there is no compensation system, and usually there is no secondary market to sell.
Swaps contracts that are easier to price and trade are called Plain Vanilla (fig. 1). In this example (link:
http://en.wikipedia.org/wiki/Swap_(finance)), A pays the floating interest rate, while B pays the fixed one, and they want to swap their rates. Both have the same notional amount of debt, on which interest rates are computed. By means of the swap contract, A will pay the fixed rate and B the floating rate. Usually, the parties underwrite the swap with a bank, which does not act as a clearing house.
The value of a swap contract can be computed at expiration of the contracts, as the difference between financial flows for the two parties.
Hull J. (2008) Options, futures and other derivatives, Prentice Hall.
Oldani C. (2008) Governing Global Derivatives, Ashgate, London.
Editor: Chiara OLDANI
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