What is a financial swap?

A financial swap is fundamentally an agreement between two parties to exchange cash flows or assets over a specified period of time. This exchange typically involves the swapping of cash flows based on different financial instruments, such as interest rates, currencies, or commodities. The most common types of swaps are interest rate swaps, where one party pays a fixed interest rate while receiving a variable interest rate from another party, and currency swaps, where two parties exchange principal and interest payments in different currencies.

The essence of a swap is its ability to manage risk and optimize financing strategies, making it a central tool in modern finance for hedging purposes and asset-liability management. This distinguishes swaps from the other concepts listed, which do not capture the fundamental characteristics of a swap. For instance, buying stocks in the future relates more to options trading, while purchasing bonds involves direct ownership rather than a cash flow exchange.