✔️ Information reviewed and updated in April 2024 by Pedro Martínez González
If you have invested or are starting in the world of investing and online trading, you have surely heard the term SWAP. A big part of learning about investing online is getting familiar with the terminology of the trading world. In this article we will go on to explain, in a very simple way, the meaning of the swap.
What is a swap in trading and how does it work?
Un swap is an inexpensive tool that is perfect for long-term investing. This term has been around quite a bit in recent years, especially in the business world. Next, its different uses and meanings in the world of investments.
What is the swap?
The word swap comes from English and literally means "exchange" And that's exactly what this technique is all about. It is based on a contract by means of which two entities (companies) agree to carry out an exchange in currencies or assets within a certain period of time.
There are two ways to carry out a swap contract: it can be done directly between both parties or through an intermediary (market). This tool is widely used by companies as a risk hedging instrument.
In summary, a swap is a contract by which two people agree to cancel a fixed amount of money or assets in the future.
Uses and importance
Swaps are increasingly important in the business world due to its great benefits. These, not only remain in obtaining an economic benefit through a transaction, but also allow in some way to restructure the debts of the company directly or indirectly. This is the main reason why it is so popular.
Swaps have different uses, but always the same purpose, to obtain benefits. Among the most common uses that this practice is given we find:
- Having an hedging against an interest rate risk.
- Speculate: it is normal that when you work with this type of financial tools you seek to obtain an economic benefit in the future. That is, get more money than what has been invested.
- Exchange of goods: there are times when a company has a good or resource that needs to be exchanged for another. It is here where it enters into swap and allows to carry out the transaction in addition, receiving a profit.
Swap types explained
There are different types of swap depending mainly on the asset you want to exchange. However, there are two that represent 80% of transactions of this type globally because they offer the best benefits.
Interest rate swap
This type of swap is the most used of all. East allows the exchange of interest on loans. One party is required to have a fixed rate and the other party a variable, in this way both companies benefit from a lower interest rate. An essential requirement of this type of swap is that both rates are reflected in the same currency.
Currency swap
Very similar to the interest swap with the exception that this type of swap uses different currencies (forex).
Commodity swap
The commodity swap is similar to the interest rate swap. However, this uses raw materials instead of money.
We explain it better, with an example: if a company (A) has oil and offers it in swap to a company (B), suppose that the swap is for a barrel that has a cost of 50 euros.
When the period is over, the new cost of the barrel is reviewed, if its price rose, A must pay B the difference, while if the price falls, B is the one who has to pay the difference to A.
Stock indices swap
Its operation remains the same, exchanging a performance from a common market to a stock market type. That is, dividends, gains and losses.
Very good explanation, it has clarified my doubts and I have understood it perfectly! Thank you!!