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.

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  1. What would motivate an entity to enter into a swap agreement?

    Learn why parties enter into swap agreements to hedge their risks, and understand how the different legs of a swap agreement ... Read Answer >>
  2. When was the first swap agreement and why were swaps created?

    Learn about the history of swap agreements, the first swap agreement between IBM and the World Bank, and how swaps have evolved ... Read Answer >>
  3. How are swap agreements financed?

    Learn how swap agreements are now cleared by swap execution facilities and require the use of collateral margin to hold, ... Read Answer >>
  4. Can bond traders trade on interest rate swaps?

    Read about interest rate swaps and why these transactions are performed by institutional actors in the bond market, not individual ... Read Answer >>
  5. How can a company hedge with currency swaps?

    Read a brief overview of how currency swap exchanges function, why a swap bank is necessary, and how the parties involved ... Read Answer >>
  6. What are the Securities and Exchange Commission regulations regarding swaps?

    Learn how the SEC regulates trading of swaps, and how swap trading is moving from an over-the-counter market to centralized ... Read Answer >>
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