Types of swaps 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. There are also many other types. Interest rate swaps A is currently paying floating, but wants to pay fixed. B is currently paying fixed but wants to pay floating. By entering into an interest rate swap, the net result is that each party can 'swap' their existing obligation for their desired obligation. Normally the parties do not swap payments directly, but rather, each sets up a separate swap with a financial intermediary such as a bank. In return for matching the two parties together, the bank takes a spread from the swap payments. The most common type of swap 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. For example, party B makes periodic interest payments to party A based on a variable interest rate of LIBOR +70basis points. Party A in return makes periodic interest payments based on a fixed rate of 8.65%. 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 as LIBOR. In reality, the actual rate received by A and B is slightly lower due to a bank taking a spread. A 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. Currency swaps ( These entail swapping both principal and interest b/w the parties, with the cashflows in one direction being in a different currency than those in the opposite direction. Commodity swaps A commodity swap is an agreement whereby a floating (or market or spot) price is exchanged for a fixed price over a specified period. The vast majority of commodity swaps involve crude oil.

Less commonly. It can be thought of as an extension or generalization of linear programming to handle multiple. . the credit event that triggers the payoff can be a company undergoing restructuring.typically a bond orloan . which in turn is a branch of multi-criteria decision analysis (MCDA). Each of these measures is given a goal or target value to be achieved. Compared to actually owning the stock. in exchange. CDS contracts have been compared with insurance. receives a payoff if a credit instrument . because the buyer pays a premium and. This can be a vector or a weighted sum dependent on the goal programming variant used. in return. Unwanted deviations from this set of target values are then minimised in an achievement function. This is an optimization programme.goes into default (fails to pay). a basket of stocks. Goal programming Goal programming is a branch of multiobjective optimization. also known as multiple-criteria decision making (MCDM). an underlying satisficing philosophy is assumed. bankruptcy or even just having its credit rating downgraded. normally conflicting objective measures. As satisfaction of the target is deemed to satisfy the decision maker(s). where the underlying asset is a stock. Unlike an actual insurance contract the buyer is allowed to profit from the contract and may also cover an asset to which the buyer has no direct exposure. receives a sum of money if one of the events specified in the contract occur. or a stock index. in this case you do not have to pay anything up front. Credit default swaps credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of payments to the seller and. but you do not have any voting or other rights that stock holders do.Equity Swap An equity swap is a special type of total return swap.

Sign up to vote on this title
UsefulNot useful