How many types of swaps are there?

Forward swap→ It is also known as delayed start swap, forward start swap or deferred start swap and is a kind of swap agreement that is often valued with two different and partial offsetting swaps and both the swaps starts immediately. But one of them ends on the date of the start of the other one known as forward swap. This swap is specially designed for the timing convenience of the investors. Total return swap→ it is the most widely used form of swap in physical commodities market or in case of equity market. It is a kind of swap agreement that allows one party to pay according to a fixed rate or according to a variable rate. But, the other party only pays according to the returns it gets from the underlying assets like loans, bonds, etc. and includes the generated income from and the capital gains of the underlying assts. Currency swap→ it is the kind of swap with the help of which all of the principal amount as well as the interest on that amount of a particular currency can be swapped with another currency and it is free of any kind of exchange rules. Circus swap→ it also termed as currency coupon swap or crosscurrency swap and includes the characteristics of both the currency swap as well as of the interest rate swap. Under this swap a loan of fixed rate of a particular currency can be replaced with a loan of floating rate of some other currency. Commodity swap→ this is a kind of swap under which all of the cash transactions are the result of the underlying commodity and hence called commodity swap. Through this swap an institution gets a fixed price from the commodity user and market price from the commodity producer. The financial institution in return facilitates the required needs of both the parties. Asset swap→ Under this swap agreement, only the floating or the fixed investments are swapped but not the fixed or floating interest rates and this swap is almost similar to the plain vanilla swap except the underlying swap contract. Interest rate swap→ it is the kind of swap agreement between two companies or banks to switch over a floating rate loan into a fixed rate loan or vice versa in different countries. The currencies into which the swap has taken place could be either same or different. Constant maturity swap→ it is the kind of swapping agreement under which a buyer has the right to set its own time duration for the received flows on a particular swap. It can of two different types termed as cross-currency swap or single currency swap. This swap allows the readjustment of a part of the interest rate periodically based on the fixed maturity rate of the market and it is a variant form of interest rate swap. But it cannot be readjusted with any floating reference index rate. Basic rate swap→ Generally, due to different rates of borrowing and lending, companies run the risk of interest rate, which is neutralized with the help of basic rate swap. It enables

the two parties involved in the agreement to exchange the interest rates varying according to money markets. Variance swap→ It is a variant of the volatility swap and under this swap the linearity of variance go along with the payout, not with the volatility as in the case of volatility swap. This difference makes the payout as the one with higher rates, not the volatility. Overnight index swap→ it simply involves the swapping of a fixed interest rate to an overnight rate. Zero basic rate→ also known as Zebra swap, actual rate swap or perfect swap and is a swap agreement between a financial intermediary and a municipality. Under this swap agreement, the financial intermediary receives from the municipality a floating rate of interest and pays to the municipality a fixed rate of interest. Roller coaster swap→ it is a kind of seasonal swap that gets created for meeting the periodical financial requirements of the counter-party and provides some liberty in terms of payment according to the periods set beforehand. So if a company is dealing in some commodity, which has its demand seasonally, then the company will surely go for a roller coaster swap. Airbag swap→ this swap gets created to counter the effects of fluctuating interest rates that puts a negative pressure on the investment. This counter effect is achieved through the adjustment of the notional value of the fluctuating interest rate by indexing the very part of the interest rate that is fluctuating to a constant maturity swap. Advantages of swaps 1. Borrowing at Lower Cost: Swap facilitates borrowings at lower cost. It works on the principle of the theory of comparative cost as propounded by Ricardo. One borrower exchanges the comparative advantage possessed by him with the comparative advantage possessed by the other borrower. The net result is that both the parties are able to get funds at cheaper rates. 2. Access to New Financial Markets: Swap is used to have access to new financial markets for funds by exploring the comparative advantage possessed by the other party in that market. Thus, the comparative advantage possessed by parties is fully exploited through swap. Hence, funds can be obtained from the best possible source at cheaper rates. 3. Hedging of Risk: Swap cal also be used to hedge risk. For instance, a company has issued fixed rate bonds. It strongly feels that the interest rate will decline in future due to some changes in the economic scene. So, to get the benefit in future from the fall in interest rate, it has to exchange the fixed rate obligation with floating rate obligation. That is to say, the company has to enter into swap agreement with a counterparty, whereby, it has to receive fixed rate interest

5 percent interest rate revenue stream (worth $65 annually) for a $1. Thus. the original investor doesn’t accrue interest for the 0. If the floating interest rate rises after terms of the rate swap are negotiated. rate agreed upon with the other party in the swap and the floating one. and the floating rate rises to 6. Currency Fluctuations 3. But. financial intermediaries can earn additional income in the form of brokerage. Additional Income: By arranging swaps. but only in the difference between the . The Disadvantages of Interest Rate Swaps Interest rate swaps are a financial tool used by large investors. In case the interest rate goes up. Money managers frequently swap floating rates for fixed rates in a rate swap in order to lock in a rate and allow for planning.and pay floating rate interest. one investor group pledges to pay a fixed interest rate on an investment to another in return for a variable interest rate on the same amount of money. the bank has to pay more interest.9 percent. Because the return on investments with floating interest rates fluctuates with the market. it has to simply swap the fixed rate with the floating rate of interest. Rate Increases for Investigators 1. the interest receipt will not go up. More complicated forms of rate swap mechanisms trade value in two currencies or a combination of interest rates and currencies.000 at 6. 5. a bank has acquired a fixed rate bearing asset on the one hand and a floating rate of interest bearing liability on the other hand.000 floating rate stream that drops to 6 percent (worth $60 annually) results in a net loss of $5 annually for the speculator. Swap can be profitably used to manage asset-liability mismatch. Now. Similar. swap is used as a tool to correct any asset. Similarly. For example. agreements can be entered into for currencies also. Thus. making the floating rate more lucrative and the investment worth more than the initial outlay.liability mismatch in interest rates in future. the asset. These strategies pose the same risks to investigators and speculators--either losing out on additional revenue when the value of one currency rises or losing money when it falls--the combination of currency exchange and interest rate prediction makes international rate swaps a complicated proposition. the receipt of fixed rate of interest by the bank is exactly matched with the payment of fixed rate interest to swap counterparty. the receipt of floating rate of interest from the swap counterparty is exactly matched with the payment of floating interest rate on liabilities. Interest rate swaps are a financial mechanism used by investors to manage risk and speculate on future market performance.liability mismatch emerges. This allows speculators to help other investors solidify their investments. 4. and the investor loses money. since. If the bank feels that the interest rate would go up. they’re more difficult to manage than fixed-rate investments. It means that the bank should find a counterparty who is willing to receive a fixed rate interest in exchange for a floating rate. the original interest-stream owner loses out on the increased interest revenue from boosted rates. the interest payment is based on the floating rate. Rate Drops for Speculators Speculative investors trade the predictability and security of fixed interest rate revenue streams for the volatility of floating rate streams predicting interest rates will rise. This can be conveniently managed by swap. Tool to correct Asset-Liability Mismatch: 2. For example. This is so because. the bank would be much affected because with the increase in interest rate. For example. If the floating rate falls. if a rate-swap is negotiated at 6. trading a $1.2 percent difference in rates. the receipt is based on the fixed rate. The net result is that the company will have to pay only floating rate of interest. In a rate swap. the value of the speculator’s investment decreases.7 percent interest. risks due to fluctuations in interest rate can be overcome through swap agreements. The fixed rate it has to pay is compensated by the fixed rate it receives from the counterparty. Now.