Price Swap Derivative
What Is a Price Swap Derivative?
A price swap derivative is a derivative transaction where one entity guarantees a fixed value for the total asset holdings of one more entity over a predetermined period. Under this type of agreement, at whatever point the value of the secured assets declines, the counterparty must deliver securities or other collateral to offset that loss and take the asset back to its original value.
Understanding a Price Swap Derivative
Price swap derivatives empower the value of one company's assets to remain consistent over a set period through the assistance of another company's distributing shares. In this sense, the price swap derivative can really conceal the way that the accepting company's financial position is debilitating after some time. Notwithstanding, when the counterparty issues new shares to fill the gap made by the brought down asset, it results in dilution of value for existing shareholders. This combination of a deceptive valuation on one side and progressively diluted stock on the other can undermine the financial standing of the two players in the agreement.
Today, price swap derivatives are moderately unusual transactions. Their rareness is due to changes in accounting rules and the availability of more normal methods to safeguard against declines in asset values.
A more normal derivative is known as a futures contract. With a futures contract, one party consents to sell an asset to one more party at a preset price on a foreordained future date. An extra type of derivative that can be utilized to safeguard against declines in asset values is called a option. Options are a derivative like futures; the chief difference is that the buyer isn't required to purchase assets when the future date shows up.
Illustration of a Price Swap Derivative
Price swap derivatives were made well known because of the Enron financial scandal. Enron utilized price swap derivatives to guarantee the value of one of its auxiliaries, a limited partnership named Raptor. Under the derivative transaction, at whatever point Raptor's assets fell below $1.2 billion, Enron vowed to give sufficient stock to the subsidiary to compensate for any shortfall and keep Raptor assets at a steady.
As this more than once occurred after some time, Enron stock made up a rising portion of Raptor's total assets. This training just increased the need to trigger transactions, since at whatever point Enron's stock fell, it would likewise bring Raptor assets below the $1.2 billion threshold. This descending spiral kept on driving Enron to issue extra shares to the subsidiary. While the speeding up derivative transactions diluted stock values for Enron shareholders, they additionally kept the company from being required to record the plunging value of the subsidiary, bringing about assisting with expanding its main concern on customary financial statements.
Features
- A price swap derivative can really conceal the way that the accepting company's financial position is debilitating over the long haul.
- A price swap derivative is a derivative transaction where one entity guarantees a fixed value for the total asset holdings of one more entity over a predefined period.
- Under this type of agreement, at whatever point the value of the secured assets declines, the counterparty must deliver securities or other collateral to offset that loss and take the asset back to its original value.
