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An exchange of payment streams between two parties for their mutual benefit. Swaps can involve an exchange of debt obligations, interest payments, or currencies with a commitment to re-exchange them at a specified time. The parties swap them because the terms available to them are not as good as those available to the other. They take the form of an exchange of cash flows between the parties so that interest rate risk or currency risk can be offset and a better match made between assets and liabilities. For example, a company may have costs it must pay in Swiss francs while its revenues are in U.S. dollars. Another company may have the opposite requirement. A bank, for a fee, arranges a currency swap, which meets both requirements. The same arrangement can be made with interest rates where two parties exchange fixed rate for floating rate risk to their mutual advantage. The two parties do not exchange the underlying debt, just cash flow or interest payments. Equity and commodity swaps are also widely traded. Most swaps are traded over the counter (OTC) but they can also be traded on futures markets.
See also: Swap Spread, Swaption, Swap Rate, Interest Rate Swap