What is a Macroeconomic Swap
A macroeconomic swap is a type of derivative designed to help companies, whose revenues are closely correlated with the business cycle, reduce their business-cycle risk. In a macroeconomic swap, also called a macro swap, a variable stream of payments based on a macroeconomic indicator is exchanged for a fixed stream of payments. The exchange occurs between an end user and a macro swap dealer.
Breaking Down the Macroeconomic Swap
Macroeconomic swaps were introduced to the market in the early 1990s. The types of economic indicators that may be used include, but are not limited to, the Consumer Confidence Index, the Wholesale Price Index, inflation rates, unemployment rates, gross national product, and gross domestic product.
In most types of swaps, the underlying asset can be traded, but this is not true for macroeconomic swaps.
Macroeconomic Swap Example
Like most swaps, two parties agree to exchange payments to each other. One makes fixed payments to the other, while the other pays a floating payment based on a changing variable. In the case of the macroeconomic swap, that variable is commonly an economic indicator.
Assume a company wants to receive payments based on the Consumer Price Index (CPI). As the index rises, they want the payments they receive to rise, offsetting the higher cost of goods they need for their business. In exchange, they pay the other party a fixed amount each month. If CPI rises, the party receiving the variable payments will see the funds they receive increase, but they continue to pay the same fixed amount to the other party. In this scenario, the party receiving the variable rate comes out ahead.
If the CPI falls, the variable payment received will decline. In this case, the fixed-payment payer is better off, since they receive the same amount but pay out less.
Swaps are traded over-the-counter. This means the parties can agree to their own terms since these types of transactions are not standardized or subject to the same regulatory scrutiny as an exchange-listed financial product. At the time of the swap the two parties will note the level of the economic indicator and then begin exchanging equal payments. Once the level of the indicator changes, the variable payment will change. For example, if the CPI rises by one percent then the variable payment may also rise by one percent (or whatever the two parties agreed to).
For simplicity, at times when the payments between the two parties are equal, actual funds may not be transferred (again, subject to the terms of the actual swap agreement). Typically, only the party who owes the higher amount pays the other.