Swap Talk and barter

The term swap is nothing new for us

The term swap is nothing new for us. We keep using this term a number of times and in various contexts. Most of the times when we use this term we generally mean to indicate a switch or a change. The meaning of the word is the same. However it can be applied into various contexts. In the context of finance, swap is generally meant to be a derivative where there are counterparties. These counterparties exchange a few benefits of one party's financial Instrument for that of the financial instrument of another party. The benefits of this exchange however depend a lot on the type and quality of the financial instrument. When it comes to swap where two bonds are involved, the benefits depend on the periodic interest payments that are generally related to the bond. Most of the times it happens that the two counterparties agree on exchanging one stream of cash flows against another stream of cash flows. These streams of cash flows are termed as the legs of the swap. A notional principal amount usually determines the calculation of the cash flows. This principal amount does not get exchanged between the counterparties. Swaps can either be in cash or in collateral. Collateral is the pledge of a borrower in lending agreements. This pledge is generally of a particular property to the lender in order to secure the repayment of the loan. This can sound a lot similar to that of mortgaging of a property. The early streaks of negotiation of swap occurred in the initial years of the 1980s. In the present times, swaps are considered to be the most heavily traded financial contracts all over the globe. There are various versions of swap as well. Some are currency swap, commodity swap, equity swap and credit default swaps. The currency swap deals with the exchange of principal and fixed rate interest payments on a loan in one particular currency for principal and fixed rate interest payments on a loan of an equal amount in some other currency. Comparative advantage plays a crucial role in currency swaps. Then comes commodity swaps. This kind of swap works on the basis of an agreement. This sees the exchange of a floating price for a fixed price. An equity swap is also known as a total return swap of a special kind. Here no payment has to be done but the individuals do not possess any rights like the other stock holders possess. A credit default swap is a type of a swap contract. It is commonly abbreviated as the CDS. In this type of swap contract, a number of payments are made to the seller. In exchange of this the other person gets a payoff if the loan or the bond is failed to be repaid. These types of swaps are often compared with the insurances as the processes of the two are quite similar indeed. Some other variations of swaps can be total return swap, swaption, variance swap and Amortising swap.

Swap Talk and barter

By: Nate Joris

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