DEFINITION of 'Reversible Swap'
An exchange of cash flows that allows one counterparty to use a swaption to switch the payor and payee of the fixed and floating rate income streams. The counterparty who is making fixed payments and receiving floating payments would begin receiving fixed payments and making floating payments, and vice versa. A reversible swap consists of an interest-rate swap plus a swaption for two times the notional principal amount of the interest-rate swap. If the notional principal amount of the interest-rate swap was $100,000, the swaption would be for $200,000.
BREAKING DOWN 'Reversible Swap'
Reversible swaps are a type of interest rate swap. They allow investors to hedge against or speculate on possible changes in interest rates. One situation when a reversible swap would be desirable is when political instability makes interest rates especially unpredictable. Other types of financial instruments investors might use to manage interest-rate risk include plain vanilla swaps, constant maturity swaps, airbag swaps, forward rate agreements and many others.