DEFINITION of 'Reverse Swap'
An exchange of cash flow streams that undoes the effects of an existing swap. Reverse swaps are used, instead of simply canceling the original swap, because they allow investors to avoid negative tax or accounting implications.
Reverse swaps also allow investors to mitigate the original risk that they are exposed to upon entering a swap, or to cancel a position if they feel that market conditions will change in such a way as to give the original swap a negative value.
BREAKING DOWN 'Reverse Swap'
Swaps are private transactions that are traded over the counter, and as such are subject to credit risk. These contracts exchange assets, liabilities, currencies, securities, equity participations and commodities. They are generally used for risk management by institutions, and are less common among individual investors.