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Definition: Zero Coupon Swap
A swap is an agreement between two parties to swap two future streams of cash flow. It is a legal agreement between the parties which is customized .In most of the cases one of the parties is an investment bank. The contract will be to swap a variable future stream of cash flow for a fixed future stream of cash flow.
Zero Coupon Bond is based on the Zero Coupon Bond. In this interest is changed and hence floating rate has to be paid in intervals. Fixed rate is paid once at the end of the agreement.
In case of a zero coupon swap, the payments of the floating rate are done on the interval basis. These payments are based on the underlying zero coupon bond. The payment of the fixed rate changes to the one-time payment. This amount is paid at the end of the agreement.
The zero coupon swap can be structured to that both the floating rate and fixed rate payments are done as a lump sum amount.