Equity Swap

DEFINITION of 'Equity Swap'

An exchange of cash flows between two parties that allows each party to diversify its income, while still holding its original assets. The two sets of nominally equal cash flows are exchanged as per the terms of the swap, which may involve an equity-based cash flow (such as from a stock asset) that is traded for a fixed-income cash flow (such as a benchmark rate), but this is not necessarily the case. Besides diversification and tax benefits, equity swaps also allow large institutions to hedge specific assets or positions in their portfolios.

BREAKING DOWN 'Equity Swap'

Most equity swaps today are conducted between large financing firms such as auto financiers, investment banks and capital lending institutions. LIBOR rates are a common benchmark for the fixed income portion of equity swaps, which also tend to be held at intervals of one year or less, much like commercial paper.

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