What is a swap and types of swaps


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How many types of swaps are there?

Forward swap→ It is also known as delayed start swap, forward start swap or deferred start swap and is a kind of swap agreement that is often valued with two different and partial offsetting swaps and both the swaps starts immediately. But one of them ends on the date of the start of the other one known as forward swap. This swap is specially designed for the timing convenience of the investors.

Total return swap→ it is the most widely used form of swap in physical commodities market or in case of equity market. It is a kind of swap agreement that allows one party to pay according to a fixed rate or according to a variable rate. But, the other party only pays according to the returns it gets from the underlying assets like loans, bonds, etc. and includes the generated income from and the capital gains of the underlying assts.

Currency swap→ it is the kind of swap with the help of which all of the principal amount as well as the interest on that amount of a particular currency can be swapped with another currency and it is free of any kind of exchange rules.

Circus swap→ it also termed as currency coupon swap or cross-currency swap and includes the characteristics of both the currency swap as well as of the interest rate swap. Under this swap a loan of fixed rate of a particular currency can be replaced with a loan of floating rate of some other currency.

Commodity swap→ this is a kind of swap under which all of the cash transactions are the result of the underlying commodity and hence called commodity swap. Through this swap an institution gets a fixed price from the commodity user and market price from the commodity producer. The financial institution in return facilitates the required needs of both the parties.

Asset swap→ Under this swap agreement, only the floating or the fixed investments are swapped but not the fixed or floating interest rates and this swap is almost similar to the plain vanilla swap except the underlying swap contract.

Interest rate swap→ it is the kind of swap agreement between two companies or banks to switch over a floating rate loan into a fixed rate loan or vice versa in different countries. The currencies into which the swap has taken place could be either same or different.

Constant maturity swap→ it is the kind of swapping agreement under which a buyer has the right to set its own time duration for the received flows on a particular swap. It can of two different types termed as cross-currency swap or single currency swap. This swap allows the readjustment of a part of the interest rate periodically based on the fixed maturity rate of the market and it is a variant form of interest rate swap. But it cannot be readjusted with any floating reference index rate.

Basic rate swap→ Generally, due to different rates of borrowing and lending, companies run the risk of interest rate, which is neutralized with the help of basic rate swap. It enables the two parties involved in the agreement to exchange the interest rates varying according to money markets.

Variance swap→ It is a variant of the volatility swap and under this swap the linearity of variance go along with the payout, not with the volatility as in the case of volatility swap. This difference makes the payout as the one with higher rates, not the volatility.

Overnight index swap→ it simply involves the swapping of a fixed interest rate to an overnight rate.

Zero basic rate→ also known as Zebra swap, actual rate swap or perfect swap and is a swap agreement between a financial intermediary and a municipality. Under this swap agreement, the financial intermediary receives from the municipality a floating rate of interest and pays to the municipality a fixed rate of interest.

 Roller coaster swap→ it is a kind of seasonal swap that gets created for meeting the periodical financial requirements of the counter-party and provides some liberty in terms of payment according to the periods set beforehand. So if a company is dealing in some commodity, which has its demand seasonally, then the company will surely go for a roller coaster swap.  

Airbag swap→ this swap gets created to counter the effects of fluctuating interest rates that puts a negative pressure on the investment. This counter effect is achieved through the adjustment of the notional value of the fluctuating interest rate by indexing the very part of the interest rate that is fluctuating to a constant maturity swap.