DEFINITION of 'Replacement Swap'

A substitute for a swap arrangement that is terminated before it matures. A swap may be ended early if there is a termination event or a default. If a swap is terminated early, both parties will cease to make the agreed-upon payments and the counterparty who caused the early termination may be required to pay damages to the other counterparty.

BREAKING DOWN 'Replacement Swap'

A replacement swap is likely to have different terms, or interest rates, than the original swap since market conditions usually will have changed. As such, the damages (called "termination payments") will factor in the difference in interest rates between the original swap and the replacement swap.

Possible termination events include legal or regulatory changes that prevent one or both parties from fulfilling the contract terms ("illegality"), the placement of a withholding tax on the transaction ("tax event" or "tax event upon merger"), or a reduction in one counterparty's creditworthiness ("credit event"). Failure to pay or a declaration of bankruptcy by either party are examples of default events. To give a real-life example, when Lehman Brothers declared bankruptcy in 2008, entities that were involved in swaps with Lehman had to seek replacement swaps.

RELATED TERMS
  1. Agreement Value Method

    The most common of three official methods established by the ...
  2. Termination Event

    An occurrence that will cause all or part of a swap agreement ...
  3. Termination Clause

    A section of a swap contract that describes what will happen ...
  4. Formula Method

    A technique for calculating termination payments on a prematurely ...
  5. Indemnification Method

    A technique for calculating termination payments when a swap ...
  6. Termination Date

    The day on which a swap contract becomes invalid and no further ...
Related Articles
  1. Managing Wealth

    An In-Depth Look At The Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  2. Trading

    How Are Interest Rate Swaps Valued?

    When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps.
  3. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  4. Trading

    Currency Swap Basics

    Find out what makes currency swaps unique and slightly more complicated than other types of swaps.
  5. Investing

    What's an Interest Rate Swap?

    An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount.
  6. Trading

    Different Types of Swaps

    Investopedia explores the most common types of swap contracts.
  7. Investing

    How To Read Interest Rate Swap Quotes

    Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes
  8. Investing

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  9. Trading

    Interest Rate Swaps Explained

    Plain interest rate swaps that enable the parties involved to exchange fixed and floating cash flows.
  10. Trading

    Hedging With Currency Swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it.
RELATED FAQS
  1. Which of the following statements least accurately describes the ways in which a ...

    The correct answer is: a) If the winning party simply terminates the swap, then he'll get zero for it. If a swap has value, ... Read Answer >>
  2. How can an investor terminate a derivative contract?

    Read a brief overview about some of the different ways that derivatives traders can terminate their contracts early, including ... Read Answer >>
  3. Who is the counterparty of a derivative?

    Learn about the counterparty to a derivative contract, and how derivative swap agreements traded over the counter have counterparty ... Read Answer >>
  4. What would motivate an entity to enter into a swap agreement?

    Learn why parties enter into swap agreements to hedge their risks, and understand how the different legs of a swap agreement ... Read Answer >>
  5. How are swap agreements financed?

    Learn how swap agreements are now cleared by swap execution facilities and require the use of collateral margin to hold, ... Read Answer >>
  6. What are some risks a company takes when entering a currency swap?

    Read about the risks associated with performing a currency swap, including counterparty credit risk in the event that one ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center