Definition of Substitution swap

Substitution swap

A swap in which a money manager exchanges one bond for another bond that is similar in
terms of coupon, maturity, and credit quality, but offers a higher yield.

Amortizing interest rate swap

swap in which the principal or national amount rises (falls) as interest rates
rise (decline).

Asset for asset swap

Creditors exchange the debt of one defaulting borrower for the debt of another
defaulting borrower.

Asset substitution

A firm's investing in assets that are riskier than those that the debtholders expected.

Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing
assets and expropriate value from the debtholders.

Asset swap

An interest rate swap used to alter the cash flow characteristics of an institution's assets so as to
provide a better match with its iabilities.

Call swaption

A swaption in which the buyer has the right to enter into a swap as a fixed-rate payer. The
writer therefore becomes the fixed-rate receiver/floating rate payer.

Circus swap

A fixed rate currency swap against floating U.S. dollar LIBOR payments.

Currency swap

An agreement to swap a series of specified payment obligations denominated in one currency
for a series of specified payment obligations denominated in a different currency.

Debt swap

A set of transactions (also called a debt-equity swap) in which a firm buys a country's dollar bank
debt at a discount and swaps this debt with the central bank for local currency that it can use to acquire local
equity.

Differential swap

swap between two LIBO rates of interest, e.g. yen LIBOR for dollar LIBOR. Payments are
in one currency.

Equity swap

A swap in which the cash flows that are exchanged are based on the total return on some stock
market index and an interest rate (either a fixed rate or a floating rate). Related: interest rate swap.

Extension swap

Extending maturity through a swap, e.g. selling a 2-year note and buying one with a slightly
longer current maturity.

Foreign exchange swap

An agreement to exchange stipulated amounts of one currency for another currency
at one or more future dates.

Import-substitution development strategy

A development strategy followed by many Latin American
countries and other LDCs that emphasized import substitution - accomplished through protectionism - as the
route to economic growth.

Interest rate swap

A binding agreement between counterparties to exchange periodic interest payments on
some predetermined dollar principal, which is called the notional principal amount. For example, one party
will pay fixed and receive variable.

Intermarket spread swaps

An exchange of one bond for another based on the manager's projection of a
realignment of spreads between sectors of the bond market.

Liability swap

An interest rate swap used to alter the cash flow characteristics of an institution's liabilities so
as to provide a better match with its assets.

Pure yield pickup swap

Moving to higher yield bonds.

Put swaption

A financial tool in which the buyer has the right, or option, to enter into a swap as a floatingrate
payer. The writer of the swaption therefore becomes the floating-rate receiver/fixed-rate payer.

Quanto swap

See: differential swap.

Rate anticipation swaps

An exchange of bonds in a portfolio for new bonds that will achieve the target
portfolio duration, based on the investor's assumptions about future changes in interest rates.

Swap

An arrangement whereby two companies lend to each other on different terms, e.g. in different
currencies, and/or at different interest rates, fixed or floating.

Swap assignment

Related: swap sale.

Swap buy-back

The sale of an interest rate swap by one counterparty to the other, effectively ending the swap.

Swap optio

See: swaption.
Related: Quality option.

Swap rate

The difference between spot and forward rates expressed in points, e.g., $0.0001 per pound sterling.

Swap reversal

An interest rate swap designed to end a counterparty's role in another interest rate swap,
accomplished by counterbalancing the original swap in maturity, reference rate, and notional amount.

Swap sale

Also called a swap assignment, a transaction that ends one counterparty's role in an interest rate
swap by substituting a new counterparty whose credit is acceptable to the other original counterparty.

Swaption

Options on interest rate swaps. The buyer of a swaption has the right to enter into an interest rate
swap agreement by some specified date in the future. The swaption agreement will specify whether the buyer
of the swaption will be a fixed-rate receiver or a fixed-rate payer. The writer of the swaption becomes the
counterparty to the swap if the buyer exercises.

Tax swap

swapping two similar bonds to receive a tax benefit.

Swap

An exchange of cash flows between two counterparties. The
counterparties may exchange flows in different currencies
(currency swap) or exchange floating interest rate payments for
fixed rate payments (interest rate swap).

Swap

A contract between two parties to exchange cash flows in the future
according to some formula.

Swaption

A swap option; an option on an interest-rate swap. The option gives
the holder the right to enter into a contracted interest-rate swap at a specified
future date. See swap.

swap

Arrangement by two counterparties to exchange one stream of cash flows for another.

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