Lesson 3 of 7 · All lessons in this module
- Forward contracts and firm commitments
- Futures contracts and daily settlementVideo lesson
- Swaps as a series of forwardsVideo lesson
- Options and call payoffsVideo lesson
- Put payoffs and the four option positionsVideo lesson
- Credit default swapsVideo lesson
- Forward commitments versus contingent claimsVideo lesson
Lesson 3 of 7 · 11 min
Swaps as a series of forwards
A swap is a firm commitment to exchange a series of cash flows, most often fixed interest for floating interest on a notional amount, which makes it a bundle of forward exchanges.
In short
- A swap commits two parties to exchange a series of future cash flows. Usually one leg is floating, reset each period to a market reference rate (MRR).
- In an interest rate swap the fixed-rate payer (floating-rate receiver) pays the swap rate; the floating-rate payer (fixed-rate receiver) pays MRR.
- The notional principal is normally not exchanged; it only scales the interest payments, which are usually netted.
- The swap rate is set so that the fixed and floating legs have equal present value, so the swap is worth zero at inception.
- Later its mark-to-market value moves away from zero: a gain to one side and an equal loss to the other. Credit terms are negotiated; cleared swaps use futures-style margin.
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