Swaps (Finance)

In finance, a swap is an agreement between two counterparties to exchange financial instruments, cashflows, or payments for a certain time. The instruments can be almost anything but most swaps involve cash based on a notional principal amount. The general swap can also be seen as a series of forward contracts through which two parties exchange financial instruments, resulting in a common series of exchange dates and two streams of instruments, the legs of the swap. The legs can be almost anything but usually one leg involves cash flows based on a notional principal amount that both parties agree to. This principal usually does not change hands during or at the end of the swap; this is contrary to a future, a forward or an option. In practice one leg is generally fixed while the other is variable, that is determined by an uncertain variable such as a benchmark interest rate, a foreign exchange rate, an index price, or a commodity price. Swaps are primarily over-the-counter contracts between companies or financial institutions. Retail investors do not generally engage in swaps.