Posted in Finance, Accounting and Economics Terms, Total Reads: 517
Definition: Call Swaption
Also known as a call swap, where purchaser has the right but not the obligation to receive a fixed interest rate as agreed upon. Swaps, a kind of derivatives is simply put an exchange of future cash flow. It is an option for over the counter interest rate swap. Swaps are an option to hedge volatile interest rates, such as currency rates or interest rates.
Call swap is bought by paying a premium when the bond issuer believes interest rate to increase. This will allow him to swap his increasing rates with the agreed upon fixed rates. This swap is used in Forex trading as a currency swap under which the interest paid is agreed upon.
An institute which likes to hedge against falling interest rates buys a call swap while that anticipating rising rates buys a put swaption. For example - If a financial institute has a large floating rate debt and it wants to convert it to fixed rate one, buying a swaption is the way to hedge its exposure to fluctuating and falling interest rate.