What is swap contract?

Before going for a swap contract, first let us know about SWAP. Swap is a derivative contract linking two parties which are involved in an exchange of cash flows of financial instruments at pre agreed rate. Applications of swap are risk hedging and to access new markets.

A swap contract is a financial derivative wherein the transacting agents can swap revenue streams arising from underlying assets, which are held by parties.

Types

Types of swaps are as follows −

These types are explained below −

• Interest rate swap − In this swap, parties agree to exchange the payments based on predetermined notional principal amounts.

• Currency swap − In this swap, parties agree to exchange both principal and interest payments denominated in different currencies

• Hybrid swap − In this swap, parties agree to exchange floating cash flows based on pre agreed price of commodity.

• Credit default swap − In this swap, the seller reimburses the buyer’s defaulted face value. The asset will transfer from buyer to seller. Due to the global financial crisis, these swaps have become notorious.