What are Swaps Derivatives?
- 22nd July 2025
- 11:00:00 AM
- 6 min read
Worried about fluctuating interest rates, currency swings, or rising global costs? Swap derivatives offer a smart way to manage these financial risks. They allow businesses and investors to exchange different types of cash flows, helping maintain financial stability in uncertain markets.
In 2025, the Reserve Bank of India’s dollar-rupee swap deal was oversubscribed, pumping USD 10.4 billion equivalent of rupees into the Indian banking system. This shows the importance of swaps in managing currency, money and risk in a fast-changing economy.
Understand the Concept of Swap Trading
When talking about trading using swaps derivatives, you can think of it as a contract between two parties. These two parties agree to exchange earnings or cash flow from two different investment instruments.
Mostly financial institutions and large businesses take part in such trades. Swap trading is available in the over-the-counter (OTC) market and not on exchanges like the NSE or BSE.
Looking at the Indian OTC market, the growth rate is at 14% CAGR. The market is anticipated to reach INR 1,57,000 crore in valuation by 2030, proving the popularity of OTC trades like Swap trading.
How Swap Trading Happens?
Here is how swap trading works when two parties enter into a swaps derivatives contract:
- In such contracts, the parties do not follow a stipulated format. Instead, contracts are tailored to the needs of the parties.
- The parties in such contracts negotiate on favourable terms and enter into one based on agreed-upon conditions.
- These contracts are not available on exchanges but are traded in the OTC market. This also makes this type of trade prone to default risks that might lead to losses.
- Different types of swaps function in different ways, and each serves a specific purpose depending on the requirements of the parties.
4 Types Of Swaps Derivatives in India
Upon understanding what are swaps derivatives, let us take a look at their types:
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Interest Rate Swaps
In the market of swaps derivatives, interest rate swaps, or IRS, are the most common. Here, one party swaps a fixed interest rate in exchange for a floating interest rate.
For example, Company X and Y enter into an IRS agreement where X agrees to pay a fixed interest of 6% on a national amount of INR 10 lakh. Y, depending on the current market rate, pays a floating interest rate to X, and the agreement is for 5 years.
Now, till the end of the agreement, payments are made at equal intervals, helping both companies to tackle the risk of interest rate changes.
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Commodity Swaps
Producers often enter into a swaps derivatives contract with commodity buyers and lock in a predetermined price for selling the commodity. This helps ensure the price stability of the commodity.
In commodity swaps, the underlying assets can be crude oil, precious metals, gold, etc. Looking at an example of a commodity like gold in India, the price of 10 grams of gold is supposed to be INR 1 lakh in 2025.
This increase can be risky for producers or the gold sellers if they lock in a lower price and miss out on gains from the price increase.
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Debt-Equity Swaps
As the name implies, this type of swaps derivatives indicates swapping equities for debt instruments. This is another form of a financial contract where, in exchange for an equity position, a party exchanges or cancels the debts of another party.
For example, consider a publicly traded company taking part in this type of swap by exchanging bonds for stocks. Such an exchange helps companies in restructuring their capital and refinancing their debts.
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Currency Swaps
This is another type of financial agreement that involves two parties who exchange loan amounts in different currencies. It also involves payments of interest on those loans.
Many businesses use this type of swap to avoid taxes imposed on foreign exchange as well as to get loans in local currencies. Governments also use such a swap to stabilise the fluctuations in the interest rates.
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Why Swaps Derivatives are Beneficial?
Upon understanding the swaps derivatives definition, let us explore its key benefits:
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Helps With Hedging
The swaps derivatives meaning this far suggest that it is a financial tool that helps manage risks against market fluctuations. Be it interest rate or currency fluctuations, such a derivative helps stabilise these fluctuations and minimise risks.
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New Market Access
Companies can gain access to new or unexplored markets with this type of trading for hedging purposes. Thus, they can take advantage of favourable borrowing conditions, currency advantages, and more.
Conclusion
Using swaps derivatives that large businesses or governments use to hedge against price fluctuations. Types of such derivatives are interest rate, commodity, debt, equity and currency swaps. These derivatives involve the exchange of cash flows generated from two different financial instruments.
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FAQ’s
1. How to calculate swap derivatives?
To calculate swaps, you must figure out the cash flow of both parties in the future using discounted cash flow analysis (DCF). The swap value is usually the difference between the present values, which are adjusted according to market rates and time to maturity.
2. What is the difference between swaps and options?
As an investor, an option gives you the right to buy underlying assets at a predetermined price and on a predetermined date. In swaps, the involved parties exchange cash flow generated using different financial instruments.
3. Why are swaps beneficial?
As swaps help in hedging risks, investors consider them beneficial. The parties in a swap contract can reduce the risk from price fluctuations in the market.
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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
