Swap

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority and you can order it here)

A 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.

In 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.

BIBLIOGRAPHY

ANDREWS, E.O. “Insurance for Rising Interest Rates.”  Venture, December, 1988.
BEIDLEMAN, C. Financial Swaps.  Dow Jones-Irwin, Inc., Homewood , IL , 1985.
BICKSLER, J., and CHEN, A.  “An Economic Analysis of Interest Rate Swaps.”  The Journal of Finance, July, 1986.
COOPER, R.  “Still Plenty of Room to Grow.”  Euromoney, October, 1986.
SMITH, C.W., and others.  “The Market for Interest Rate Swaps.”  Financial Management, Winter, 1988.  

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