What is a Swap in finance?

In finance it is called a swap, a type of contract made between two parties, whose objective is the exchange of cash flows futures. They are financial contracts that are not carried out in a standard way, so they are not the object of exchanges in markets or exchanges, but are carried out in each case, ad hoc, between a particular company and a bank, to satisfy the needs of the parties .

They are normally used to exchange interest flows, specifically to exchange fixed interests for variables or vice versa. This is precisely the most common type of swap. In this case, the swap affects only one currency. However, it is not the only type of swap that exists. Swaps can also affect exchange rates of the coins.

Swap contracts establish the formulas by which the cash flows are exchanged between the parties, and specify the applicable interest rates, the relevant terms or dates. The currencies on which the corresponding exchanges are made are also specified.

Swaps are made on the same amount and period of time, on which a formula is applied to calculate interest on a fixed rate or variable rate. For example, if a company that has a variable interest contract really wants to pay a fixed rate, it can formalize a swap contract in which the flow exchange formula will be established.

In this way, the financial entity with which the contract is signed will take charge of the variable rate, and the company will be obliged to pay the bank the fixed rate, calculated in accordance with the provisions of the contract.

The same can be done in a swap to exchange flows in foreign currency. In this case, the two currencies and the calculation formula will be specified.

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