A swap is an agreement between two parties to exchange streams of cash flows over time. Where a future settles on one date, a swap keeps settling — payment after payment — across its life.
The classic: an interest-rate swap
The most common swap exchanges fixed interest payments for floating ones:
- Party A pays a fixed rate (say 4%) on a notional amount.
- Party B pays a floating rate (a benchmark like SOFR, which moves over time).
- Only the net difference changes hands each period — the notional itself is never exchanged; it’s just the basis for the calculation.
Why transform fixed ↔ floating?
Swaps let a company reshape risk without touching its underlying loans:
- A business with a floating-rate loan worried about rising rates can swap into fixed, locking in its cost.
- An investor expecting rates to fall might swap fixed into floating to benefit.
You change your exposure by adding a swap on top, rather than refinancing.
Other flavours
- Currency swaps — exchange principal and interest in one currency for another (covered next).
- Commodity swaps — exchange a fixed price for a floating market price on a commodity.
- Total return swaps — exchange the total return of an asset for a fixed or floating payment.
Where they live
Swaps are mostly over-the-counter — customised contracts between institutions (banks, corporates, funds) rather than exchange-traded. That flexibility is their strength, but it brings counterparty risk and, historically, less transparency (post-2008 reforms pushed many swaps toward central clearing).
The takeaway
A swap is a way to rent a different risk profile over time — fixed vs floating, one currency vs another — without unwinding what you already hold. It’s the institutional workhorse for managing interest-rate and currency exposure.