financial transaction in which two counter parties agree to exchange streams
of payments over time according to a predetermined rule.
A swap is normally used to transform the market exposure associated
with a loan or bond borrowing from one interest rate base (fixed term
of floating rate) or currency of denomination to another.
Central banks use swap arrangements as reciprocal short-term credit
agreements to obtain foreign exchange for intervention in the foreign
exchange market. The central
bank obtains domestic currency in exchange for forcing currency.
bond swapping, the switch is from one fixed-income security to another
fixed-income security having the same or different coupon, maturity, quality
rating, yield level, and other features.
Investors usually swap bonds to gain increased current income or
yield to maturity (yield-pickup swap); to obtain better price performance
should there be a movement in interest rates (rate anticipation swap);
to purchase or sell a security at a historically attractive yield relative
to other similar issues (substitution swap); to purchase or sell a security
at a historically attractive yield compared to other groups or types (sector
swap); or to attain other investment objectives - tax minimization, portfolio
diversification, portfolio concentration.
E.O. "Insurance for Rising Interest Rates."
Venture, December, 1988.