Where do individual investors typically encounter the term 'swap'?

Most often as the 'swap points' in foreign exchange margin trading (FX), which reflect the interest rate differential paid or received between two currencies. This is an application of the currency swap concept and accrues on a daily basis as long as a position is held.

Are there risks involved in swap transactions?

Yes. Changes in interest rates or exchange rates can reverse the direction of the payments you were expecting to make or receive. In leveraged trades such as FX, the impact of unrealized gains or losses from exchange-rate movements can also end up larger than the swap points themselves.

What Is a Swap?

A swap is a transaction in which two parties agree to exchange cash flows, such as interest payments or currency amounts, based on predetermined terms.

Main types

Representative examples include an "interest rate swap," which exchanges fixed-rate and floating-rate interest payments, and a "currency swap," which exchanges cash flows denominated in different currencies. These transactions are used mainly by financial institutions and companies to manage interest rate and currency risk.

What to keep in mind

For individual investors, the most familiar form is the "swap points" in foreign exchange margin trading (FX), which reflect the interest rate differential adjustment between two currencies. If the interest rate differential narrows or reverses, the direction of the swap points you receive (or pay) can also change, so it is important to understand this alongside the exchange-rate risk that comes with leverage.

This article is provided for general informational purposes only and does not recommend or solicit the purchase or sale of any specific investment method or security. Final investment decisions are your own responsibility.

Frequently Asked Questions

Where do individual investors typically encounter the term 'swap'?: Most often as the 'swap points' in foreign exchange margin trading (FX), which reflect the interest rate differential paid or received between two currencies. This is an application of the currency swap concept and accrues on a daily basis as long as a position is held.
Are there risks involved in swap transactions?: Yes. Changes in interest rates or exchange rates can reverse the direction of the payments you were expecting to make or receive. In leveraged trades such as FX, the impact of unrealized gains or losses from exchange-rate movements can also end up larger than the swap points themselves.

Related terms

Derivatives