Derivatives basics
Swaps
3 min
A swap is a contract to exchange (swap) two streams of cash flows over time. Nothing is bought outright; the parties simply agree to pay each other on a schedule based on some reference.
The most common type: an interest-rate swap
The classic example exchanges a fixed interest payment for a floating one on the same notional amount.
Notional: US$10,000,000 (never exchanged - reference only)
Party A pays: fixed 5% per year -> 500,000/yr
Party B pays: floating rate (e.g. SOFR + 1%)
They net the difference each period.
A company with a floating-rate loan that fears rising rates can use this swap to effectively convert its debt to a fixed rate — a pure hedge against rate increases.
Other swaps you will meet
- Currency swaps — exchange principal and interest in two different currencies.
- Commodity swaps — swap a floating commodity price for a fixed one.
- Credit default swaps (CDS) — pay a premium for protection against a borrower defaulting; effectively insurance on debt.
Why they matter to you
Swaps are mostly an institutional tool, but the concept appears directly in retail trading: the overnight swap/financing charge on a forex or CFD position is a tiny daily interest-rate swap between you and your broker. The CFD chapter returns to this.
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