Forward Swap

What Is a Forward Swap?

A forward swap, likewise called a deferred or delayed-start swap, is an agreement between two gatherings to exchange cash flows or assets on a fixed date from here on out, and which additionally begins sometime not too far off (determined in the swap agreement).

Interest rate swaps are the most common type of swap that utilizes a forward swap, in spite of the fact that it could include other financial instruments too.

Figuring out Forward Swaps

A swap is a derivative contract through which two gatherings exchange the cash flows or liabilities from two distinct financial instruments. A forward swap defers the beginning date of the obligations agreed to in a swap agreement made at some prior point in time.

Forward swaps can, hypothetically, incorporate various swaps. All in all, the two gatherings can consent to start trading cash flows at a predetermined future date and afterward consent to one more set of cash flow exchanges to start at one more date past the first, recently agreed-upon swap date. For instance, on the off chance that an investor needs to hedge for a five-year duration beginning one year from today, this investor can go into both a one-year and six-year swap.

With regards to an interest rate swap, the exchange of interest payments will begin sometime not too far off agreed to by the counterparties to this swap. In this swap, the effective date is some time or another later on, yet greater than the standard one or two business days that are regular of a swap. For instance, the swap might produce results three months after the trade date.

Swaps are helpful for investors seeking to a hedge their borrowing on the expectation that interest rates (or exchange rates) will change from here on out. The delayed beginning of the forward swap contract eliminates the need to pay for the transaction today (thus the term "deferred start").

The calculation of the swap rate is like that for a standard swap (additionally called a vanilla swap).

Forward Swap Example

Company A has taken a loan for $100 million at a fixed interest rate; Company B has taken a loan for $100 million at a floating interest rate. Company An expects that interest rates six months from now will decline and consequently needs to change over its fixed rate into a floating one to reduce loan payments.

Then again, Company B accepts that interest rates will increase six months later and needs to reduce its liabilities by switching over completely to a fixed-rate loan. The key to the swap, beside the change in the organizations' perspectives on interest rates, is that the two of them need to sit tight for the genuine exchange of cash flows (six months in this case) while securing in right now the rate that will determine that cash flow amount.

Features

• Forward swaps permit financial institutions to hedge risk, participate in arbitrage, and exchange cash flows or liabilities.
• Forward swaps happen most commonly with interest rate swaps, where interest payments are set to be exchanged beginning sometime not too far off.
• Forward swaps, or deferred swaps, feature a delayed beginning to a swap agreement.