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Template:Swap - layman: Difference between revisions
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[[File:Noel.png|thumb|A swap pioneer from the 1970s]] | [[File:Noel.png|thumb|A swap pioneer from the 1970s]] | ||
{{tag|Swap}}s come in all shapes and sizes, but at their heart they are agreements to exchange — “swap” — payment streams. In the simplest example, you and I could agree, for a period of 5 years, that I will pay you a fixed rate on an agreed sum, and you will pay me a floating rate on the same sum. We don't pay the actual sum itself. | {{tag|Swap}}s come in all shapes and sizes, but at their heart they are agreements to exchange — “swap” — [[cash flow|payment streams]]. In the simplest example, you and I could agree, for a period of 5 years, that I will pay you a fixed rate on an agreed sum, and you will pay me a floating rate on the same sum. We don't pay the actual sum itself. | ||
Why would we do exchange those cashflows then? | Why would we do exchange those cashflows then? | ||
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Used in this way, a [[swap]] is a form of [[insurance]]. Bankers call this kind of insurance a [[hedge]]. | Used in this way, a [[swap]] is a form of [[insurance]]. Bankers call this kind of insurance a [[hedge]]. | ||
You can enter a swap even if you don't own a source of income paying you the rate you are swapping away. Bankers have all kinds of imaginative names for this kind of activity: [[pre-hedging]]; seeking [[alpha]]; yield-enhancing, but you will know it as [[gambling]]. Warren Buffett calls swaps financial | You can enter a swap even if you don't own a source of income paying you the rate you are swapping away. Bankers have all kinds of imaginative names for this kind of activity: [[pre-hedging]]; seeking [[alpha]]; yield-enhancing, but you will know it as [[gambling]]. Warren Buffett calls swaps “[[financial weapons of mass destruction]]”. This is a bit of hyperbole, but he still felt pretty smug when the world nearly blew up in 2008 because of complex [[Derivative|derivatives]] called [[credit default swap]]s | ||
You can swap all kinds of | You can swap all kinds of [[cash flow|cashflow]]s - not just interest rates. [[Cashflow]]s can be derived from any financial asset: bonds, [[shares]], [[commodities]], and even repackaged [[cashflow]]s on sub-prime mortgages<ref>Don’t do this. I mean, really, don’t.</ref>. | ||