(FINANCE) a type of financial derivative which
two parties "swap," or exchange, the streams of income (or payments) from
two different sources. The actual instrument is created by a third party, such as an investment
bank.
The most familiar version of the swap is the interest rate swap, in which the holder of a fixed
rate loan and the holder of an adjustable
rate loan agree to exchange revenue streams.
The variety of swaps available is massively greater than with options or futures; essentially, swaps exist for every arbitrage opportunity that any combination of markets provides; the market for swaps is huge.
BILL: Why do firms buy swaps? Why don't they just sell the loans they have to other banks, or
whatever?
ANNA: One is that swaps are a method of hedging risk; you hold the bond in case the price goes up, but you buy interest rate swaps to protect against having average rates in your portfolio that are two high or two low.
