What is a swap transaction?
A contract to exchange two financial liabilities. For example, swapping fixed interest-rate debts for variable-rate debts. They are commonly used to enable a borrower to change the basis of interest payments and will often incur a fee.
Key takeaways
Swap transactions are contracts to exchange two financial liabilities, such as swapping fixed interest-rate debts for variable-rate debts, commonly used by companies, financial institutions, and public authorities to change the basis of interest payments.
Companies use swap transactions to protect against interest rate risks, such as offsetting the cost of potential interest rate declines, and typically pay a set percentage fee as part of the agreement.
Foreign exchange swaps consist of two legs—a spot transaction and a forward transaction—both executed simultaneously for the same quantity to offset each other when companies have currencies the other requires.
Common types of swap transactions include currency swaps, debt swaps, and commodity swaps.
Where have you heard about swap transactions?
Swap transactions are regularly referred to in the Financial Times and other financial news sources when they are used by companies, financial institutions and sometimes public authorities.
What you need to know about swap transactions.
A company may issue bonds with a variable interest rate. They may then protect against the risk of a rate drop by undertaking a swap transaction to offset the cost of any potential decline in interest. They will typically pay a set percentage fee as part of the agreement.
In foreign exchange swaps, there are two legs – a spot transaction and a forward transaction. Both are executed at the same time for the same quantity, and therefore offset. They occur if both companies have a currency that the other requires.
Other common swap transactions include currency swaps, debt swaps and commodity swaps.