Zero Coupon Swap

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DEFINITION of 'Zero Coupon Swap'

An exchange of income streams in which the stream of floating interest-rate payments is made periodically, as it would be in a plain vanilla swap, but the stream of fixed-rate payments is made as one lump-sum payment when the swap reaches maturity instead of periodically over the life of the swap. The amount of the fixed-rate payment is based on the swap's zero coupon rate.

BREAKING DOWN 'Zero Coupon Swap'

Variations of the zero coupon swap exist to meet different investment needs. A reverse zero-coupon swap pays the lump-sum payment when the contract is initiated, reducing credit risk for the pay-floating party. An exchangeable zero-coupon swap can use an embedded option to turn the lump-sum payment into a series of payments. It is also possible for the floating-rate payments to be paid as a lump sum in a zero-coupon swap.

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