Swap

What is a swap?

In general, a swap is the exchange of one asset or liability for a similar asset or liability for the purpose of lengthening or shortening maturities, or raising or lowering coupon rates, to maximize revenue or minimize financing costs. This may entail selling one securities issue and buying another in foreign currency; it may entail buying a currency on the spot market and simultaneously selling it forward. Swaps also may involve exchanging income flows; for example, exchanging the fixed rate coupon stream of a bond for a variable rate payment stream, or vice versa, while not swapping the principal component of the bond. Swaps are generally traded over-the-counter. (Source: CFTC)

Bond Swaps

A bond swap occurs when an investor sells one bond and uses the proceeds to purchase another bond, often at the same price. Investors engage in bond swaps for a variety of reasons. For example, investors may want to take a tax loss by selling one bond at a loss but then preserve their investment by simultaneously buying a similar bond. At other times, investors swap bonds to obtain a higher yield and return on their bond investments. (Source: SEC)

In finance, a swap is a derivative, where two counterparties exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The cash flows are calculated over a notional principal amount. Swaps are often used to hedge certain risks, for instance interest rate risk. Another use is speculation.

Swaps are over-the-counter (OTC) derivatives. This means that they are negotiated outside exchanges. They cannot be bought and sold like securities or futures contracts, but are all unique. As each swap is a unique contract, the only way to get out of it is by either mutually agreeing to tear it up, or by reassigning the swap to a third party. This latter option is only possible with the consent of the counterparty. (Source: Wikipedia)