Posted in Finance, Accounting and Economics Terms, Total Reads: 1143
Swap is an agreement or a contract between two parties to exchange cash flows where one of the flows is a fluctuating quantity such as floating interest, currency and the other is a fixed cash flow. Swapping is usually maintained as a hedging instrument and is done against the following variables:
Currency swapping is where interest is paid on an equal principle in their respective currencies and the difference in their
Interest rate swapping – These swaps are taken on the floating quantity (interest) which I are published by an independent party to avoid any conflict. It is between a fixed interest rate and a floating interest rate. Usually the LIBOR rate is taken as the floating rate.
Credit default swapping- The firm which is going into bankruptcy and is not in a position to repay the interest on its borrowings makes certain payments through credit swaps.
Commodity swapping –However it only involves the nominal exchange of money. It is usually between the market rate also known as the spot rate and the fixed rate.
Currency swap - If a European company wants to acquire Thai currency Baht and the Thai company wants to acquire Euro then a rate of interest is decided between the two parties the interest will be paid in the other’s currency till the period of maturity which usually lasts for 10 years.
Commodity Swap – In a volatile market if the price of crude oil is expected to fall then it is hedged using a commodity swap. The producer doesn’t want to incur a loss so he sells the crude oil at the market rate and draws a fixed annual sum of payments in return. This is usually done to protect from the downside loss. However, if the oil prices appreciate which are governed by the oil price index then the producer may not be able to maximize his profits.