In derivatives, a swap is a contract where one party exchanges the cash flows or value of one asset for another. What do the parties exchange?

• A. The cash flows or value of one asset for another
• B. Stock certificates for cash
• C. Ownership of the underlying asset
• D. A fixed dividend

Answer: (A)

The core idea is that a swap exchanges payment streams, not the actual asset itself. In a swap, each party agrees to pay the other the cash flow tied to one asset in exchange for the cash flow tied to another asset, using a notional amount as the basis. For example, an interest rate swap swaps floating-rate payments for fixed-rate payments on the same notional, while a currency swap involves exchanging principal and interest in different currencies. The underlying asset or stock certificates aren’t transferred, and fixed dividends aren’t exchanged. So the parties exchange the cash flows (or the value derived from those assets) for each other.