Agreement between two parties to exchange assets or sets of financial obligations or a series of cash flows for a specified period

of time at predetermined intervals.

Swaps are derivatives instruments used for risk management purpose.
Swaps

Interest Rate Swap

Currency Swap

Equity Swap

Transaction between two parties involving an exchange of one stream of cash flow (Fixed / floating) for another (fixed / floating) for specific maturity on a notional principal amount . Principal is not exchanged at initiation/termination of contract.

Possible combinations: Pay Fixed Received Fixed Pay Fixed Received Floating Pay floating Received fixed Pay Floating Received Floating
2

Party A is a floating rate payer at LIBOR + 2% on $1m He is expecting that interest rates will rise He wants to change his position from floating to fixed payer. Party A will enter into a contract with Bank on same principal amount (notional)
4% on 1Million
LIBOR on 1Million Bank

1m @ LIBOR+2%

Party A (Floating rate payer)

Coupon swap (Pay fixed & received floating)

Basis swap (Floating Floating ; based on difference reference rates. Eg. 1 m USD LIBOR for 1 m GBP LIBOR) Bond swap - Purchase & sale of two or more bonds to earn additional yield differential.

Substitution Swap - exchange of one bond for a perfect substitute bond to earn additional yield due to transitory mispricing. Tax Swap Non taxable municipal bonds swapped with corporate bonds of same risk to increase the after tax return.
4

One party makes payments denominated in one currency, while payments from the other party are made in second currency. The notional amount of contract in both currencies are exchanged at contract initiation & returned at contract termination.

SWAP INITIATION
The Indian Firm wants USD.Has or can borrow INR Swaps INR for USD Swaps USD for INR The US firm wants INR. Has or can borrow USD

SWAP INTEREST PAYMENT

The Indian Firm has use of Indian pays USD interest USD
US firm pays INR interest

The US firm has use of INR

SWAP TERMINATION
The Indian Firm returned the USD borrowed

USD Returned
INR Returned

The US firm returned the INR borrowed

6

In equity swap, the return on a stock , a portfolio, or a stock index is paid each period by one party for fixed rate or floating rate payment.

Swaps typically require no payment by either party at initiation Swaps are custom instruments Swaps are not traded in any organized secondary market Swaps are largely unregulated Default risk is an important aspect of the contracts Most participants in the swaps market are large institutions
7

Mutual Termination - If both parties are ready to terminate the contract early, then they can mutually terminate the contract. Offsetting contract - If the original counterparty is not accepting the early termination then we can enter into another swap that can offset our existing position. Resale - Sell swap to another party with permission of counterparty. Swapation - Option to enter into a swap after a fixed time. This gave us an option to terminate the existing swap.
8