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As the name suggests, a swap contract is an agreement by two parties to exchange, or swap, specified cash flows at specified intervals. Swaps are a recent innovation; they were first introduced to the public in 1981 when IBM and the World Bank entered into a swap agreement. The market for swaps has grown tremendously since that time.

A swap contract is really just a portfolio, or series, of forward contracts. Recall that with a forward contract, one party promises to exchange an asset (e.g., bushels of wheat) for another asset (cash) on a specific future date. With a swap, the only difference is that there are multiple exchanges instead of just one. In principle, a swap contract could be tailored to exchange just about anything. In practice, most swap contracts fall into one of three basic categories: currency swaps, interest rate swaps, and commodity swaps. Other types will surely develop, but we will concentrate on just these three.

swap contract

An agreement by two parties to exchange, or swap, specified cash flows at specified intervals in the future.

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