Swap Definition. A Swap in the financial markets is a derivative in which each counterparty exchanges certain benefits of one party’s financial instrument for those of the other party’s financial instrument. A typical interest rate swap may exchange an adjustable rate of interest cash flow for a fixed rate-of-interest cash flow. These two cash flow streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are to be computed. Swaps can be used as a hedging tool to mitigate certain risks, such as interest rate risk, or can be used to speculate on anticipated price movements in the market on the underlying asset. There are five general types of swaps, listed here by quantitative level of usage: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps. The total possibilities are endless. A Currency Swap, or forex swap or FX swap, is a simultaneous purchase and sale of identical amounts of one currency for another currency with two different value dates, typically spot to forward. Institutions account for the bulk of the usage to fund their foreign exchange positions. Cash flows can be exchanged for both principal and interest (cross-currency swap), interest only (coupon-only swap) and only principal (principal-only swap).
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