DEFINITION of 'Reverse Swap'

A reverse swap is an exchange of cash flow streams that undoes the effects of an existing swap. When investing in derivatives such as futures, forwards, and swaps, there are a handful of ways to exit or cancel an existing contract. One of the ways is to enter into what is called an "offsetting position." An offsetting position is a contract that has the reverse specifications of the original contract, therefore undoing the original contract. 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. In a swap, this credit risk that the other party may not deliver on their part of the bargain is called "counterparty 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.

RELATED TERMS
  1. Asset Swap

    An asset swap is a derivative contract through which fixed and ...
  2. Foreign Currency Swap

    A foreign currency swap is an agreement to exchange currency ...
  3. Termination Date

    A termination date is the day on which a swap contract ends, ...
  4. Basis Rate Swap

    A basis rate swap is a type of swap in which two parties swap ...
  5. Accreting Principal Swap

    An accreting principal swap is a derivative contract that features ...
  6. Performance Index Paper (PIP)

    Performance Index Paper (PIP) is short-term commercial paper ...
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

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  3. 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.
  4. Trading

    Different Types of Swaps

    Identify and explore the most common types of swap contracts. Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific ...
  5. Trading

    How To Value Interest Rate Swaps

    An interest rate swap is a contractual agreement between two parties agreeing to exchange cash flows of an underlying asset for a fixed period of time.
  6. 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
  7. Investing

    CFTC Probes Banks' Use of Interest Rate Swaps

    U.S. regulators are probing banks' trading and clearing of interest rate swaps, which played a central role in the 2008 financial crisis
  8. Investing

    The Advantages Of Bond Swapping

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

    The Fast-Paced World of Libor & Fixed Income Arbitrage

    LIBOR is an essential part of implementing the swap spread arbitrage strategy for fixed income arbitrage. Here is a step-by-step explanation of how it works.
  10. Investing

    Is Your Mutual Fund Safe?

    You might be carrying more risk than you think if your fund invests in derivatives.
RELATED FAQS
  1. How do companies benefit from interest rate and currency swaps?

    Interest rate and currency swaps help companies manage exposure to rate fluctuations and acquire a lower rate than they would ... Read Answer >>
  2. How do currency swaps work?

    Learn how a currency swap works, including who uses these transactions, and the mechanics and purpose of the different cash ... Read Answer >>
  3. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative. Read Answer >>
  4. What Is a 'Gypsy Swap'?

    A gypsy swap allows a company to raise capital without issuing debt or holding a secondary offering. Read Answer >>
  5. What are some examples of risks associated with financial markets?

    Find out about the different types of risks for different classes of assets including volatility, counterparty risk and default ... Read Answer >>
Trading Center