Swap

Swaps let companies, banks and investors change the nature of their financial exposures without buying or selling the underlying assets. The agreed principal amount, called the notional amount, is used to calculate the payments, but often is not itself exchanged.

The most common type is the interest rate swap, where one party pays a fixed interest rate and the other pays a floating rate. Other types include currency swaps, which exchange payments in different currencies; credit default swaps, which provide protection against a borrower defaulting; commodity swaps, which exchange fixed and floating commodity prices; and equity swaps, which exchange the return on a share or index for another payment.

For example, a company with a floating-rate loan worried about rising interest rates could enter a swap to pay a fixed rate and receive a floating rate, effectively converting its loan to a fixed rate.

Swaps are mostly arranged privately between parties, traditionally through banks, rather than traded on exchanges, although many standard swaps must now be cleared through central clearing houses. The global swaps market is enormous, measured in hundreds of trillions of dollars of notional value.