What is Swap (Derivative Swap)?

A swap is a derivative contract that enables parties to exchange the cash flows or value of one asset to another. Usually swaps involve cash flows contingent on a notional principal amount such as a bond or loan. Generally, the principal amount does not change hands during a swap, while different portions of cash flow in the agreement make up one leg. Often one cash flow exchange is fixed while the other(s) are variable based on a floating exchange rate, specific interest rate, or index price. Derivatives swaps are typically carried out by large institutions and take place over the counter (OTC).