Writing Resources
Introduction A swap is an agreement or a derivative contract between two counterparties to exchange cash flows This exchange takes place at specified future dates as mentioned in the contract Swaps do not trade on exchanges and are traded mostly over the counter OTC Swaps are custom instruments and largely unregulated Subject to default risk Swaps typically require no payment by either party at the beginning of the contract Exchanges only the net amount owed from one party to the other Types of Swaps 1 Interest Rate Swap This is the most common type of swap which is a contract between two counterparties to exchange fixed payment cash flow for floating payment cash flow or vice versa based on a specified principal amount on specified dates in the future It is mainly used to hedge the interest rate risk Interest Rate Swaps do not require the exchange of the notional principal amount of the contract Figure 1 Interest Rate Swap In the above example Bank has given a loan to Party A based on a floating interest rate LIBOR and Party
