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What is a swap contract?

Curious about derivatives

What is a swap contract?

A swap contract is a derivative instrument that allows two parties to exchange one stream of cash flows for another. In a swap contract, the two parties agree to exchange cash flows based on a predetermined set of terms.

For example, in an interest rate swap, one party agrees to pay a fixed interest rate on a notional principal amount, while the other party agrees to pay a variable interest rate on the same notional principal amount. The fixedrate payer is betting that interest rates will rise, while the variablerate payer is betting that interest rates will fall.

Swaps are typically used by institutional investors and corporations to manage their exposure to interest rate, currency, or credit risks. They can be customized to meet the specific needs of the parties involved, and can be used for hedging, speculation, or arbitrage. However, swaps are also complex financial instruments that carry risks, including counterparty risk and market risk.

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