Overview

Swaps are off-balance sheet instruments involving combinations of two or more basic building blocks. Most swaps currently traded in the market involve combinations of cash market securities, for example a fixed interest rate security combined with a floating interest rate security, possibly also combined with a currency transaction. However the market has also seen swaps that involve a futures or forward component, as well as swaps that involve an option component. The market in say, dollar, euro and sterling interest rate swaps is very large and very liquid. The main types of swap are interest rate swaps, asset swaps, basis swaps, fixed-rate currency swaps and currency coupon swaps. The market for swaps is organised by the International Swap Dealers Association.

Swaps are now one of the most important and useful instruments in the debt capital markets. They are used by a wide range of institutions, including banks, mortgage banks and building societies, corporates and local authorities. The demand for them has grown as the continuing uncertainty and volatility of interest rates and exchange rates has made it ever more important to hedge their exposures. As the market has matured the instrument has gained wider acceptance, and is regarded as a plain vanilla product in the debt capital markets. Virtually all commercial and investment banks will quote swap prices for their customers, and as they are OTC instruments, dealt over the telephone, it is possible for banks to tailor swaps to match the precise requirements of individual customers. There...