what is called a swap in finance?

In finance, a swap is a financial contract between two parties where they agree to exchange one set of cash flows for another, based on a specific underlying asset or reference rate. Swaps are used to manage risk or speculate on changes in the underlying asset or reference rate.

There are several types of swaps, but the most common are:

Interest rate swaps: Two parties agree to exchange a fixed interest rate for a floating interest rate, or vice versa, based on a specific underlying reference rate such as LIBOR. This allows the parties to hedge against changes in interest rates or to speculate on changes in interest rates.


Currency swaps: Two parties agree to exchange a set of cash flows in one currency for a set of cash flows in another currency. This allows the parties to hedge against changes in exchange rates or to speculate on changes in exchange rates.


Commodity swaps: Two parties agree to exchange a set of cash flows based on a specific commodity price for a set of cash flows based on another commodity price. This allows the parties to hedge against changes in commodity prices or to speculate on changes in commodity prices.


Credit Default swaps: Two parties agree to exchange a set of cash flows based on the credit risk of a specific entity (such as a company or a sovereign nation) This allows the parties to hedge against the risk of default or to speculate on the default risk of an entity.

Swaps are usually over-the-counter (OTC) derivatives, which means that they are traded directly between two parties, rather than on an exchange. This also implies that the counterparty risk is relatively high.