Template:Swap - layman

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A swap pioneer from the 1970s

Swaps come in all shapes and sizes, but at their heart they are an agreement to exchange payment streams. In the simplest example, we could agree for a period of 5 years that I will pay you a fixed interest rate on a notional sum of money, and you will pay me a floating rate on that same sum.

Why would you do that?

Well, imagine you had an income source paying you a floating rate (for example, a corporate bond), but you had a liability requiring you to pay a fixed rate (say your mortgage).

Finding a swap counterparty to swap]] your floating rate income for a fixed rate means you will be able to meet your mortgage obligations from the proceeds of that bond, without having to worry about what happens if floating interest rates fall.

Used in this way, a swap is a form of hedging.