Swaps are described as derivative contracts where one party exchanges cash flows or value of one asset for another. This best illustrates which concept?

• A. Exchanging cash flows between assets
• B. Purchasing ownership in a company
• C. Issuing new equity
• D. Rehypothecation of collateral

Answer: (A)

Swaps illustrate that derivatives derive value from exchanging payment streams rather than transferring ownership. In a swap, two parties agree to swap cash flows tied to different assets or benchmarks. For example, in an interest rate swap, one side pays a fixed rate on a notional amount while the other pays a floating rate; the payments are exchanged while the underlying principal is typically not exchanged. This captures the idea of exchanging cash flows between assets. It isn’t about buying ownership in a company, issuing new equity, or reusing collateral, which are unrelated to the fundamental mechanism of a swap.