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Equity swap
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Equity swap
An equity swap is a financial derivative contract (a swap) where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. The two cash flows are usually referred to as "legs" of the swap; one of these "legs" is usually pegged to a floating rate such as LIBOR. This leg is also commonly referred to as the "floating leg". The other leg of the swap is based on the performance of either a share of stock or a stock market index. This leg is commonly referred to as the "equity leg". Most equity swaps involve a floating leg vs. an equity leg, although some exist with two equity legs.
An equity swap involves a notional principal, a specified duration and predetermined payment intervals.
Equity swaps are typically traded by delta one trading desks.
Typically equity swaps are entered into in order to avoid transaction costs (including Tax), to avoid locally based dividend taxes, limitations on leverage (notably the US margin regime) or to get around rules governing the particular type of investment that an institution can hold.
Equity swaps also provide the following benefits over plain vanilla equity investing:
Equity swaps, if effectively used, can make investment barriers vanish and help an investor create leverage similar to those seen in derivative products. However a clearing house is needed to settle the contract in a neutral location to offset counterparty risk.
Investment banks that offer this product usually take a riskless position by hedging the client's position with the underlying asset. For example, the client may trade a swap – say Vodafone. The bank credits the client with 1,000 Vodafone at GBP1.45. The bank pays the return on this investment to the client, but also buys the stock in the same quantity for its own trading book (1,000 Vodafone at GBP1.45). Any equity-leg return paid to or due from the client is offset against realised profit or loss on its own investment in the underlying asset. The bank makes its money through commissions, interest spreads and dividend rake-off (paying the client less of the dividend than it receives itself). It may also use the hedge position stock (1,000 Vodafone in this example) as part of a funding transaction such as stock lending, repo or as collateral for a loan.
Parties may agree to make periodic payments or a single payment at the maturity of the swap ("bullet" swap).
Hub AI
Equity swap AI simulator
(@Equity swap_simulator)
Equity swap
An equity swap is a financial derivative contract (a swap) where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. The two cash flows are usually referred to as "legs" of the swap; one of these "legs" is usually pegged to a floating rate such as LIBOR. This leg is also commonly referred to as the "floating leg". The other leg of the swap is based on the performance of either a share of stock or a stock market index. This leg is commonly referred to as the "equity leg". Most equity swaps involve a floating leg vs. an equity leg, although some exist with two equity legs.
An equity swap involves a notional principal, a specified duration and predetermined payment intervals.
Equity swaps are typically traded by delta one trading desks.
Typically equity swaps are entered into in order to avoid transaction costs (including Tax), to avoid locally based dividend taxes, limitations on leverage (notably the US margin regime) or to get around rules governing the particular type of investment that an institution can hold.
Equity swaps also provide the following benefits over plain vanilla equity investing:
Equity swaps, if effectively used, can make investment barriers vanish and help an investor create leverage similar to those seen in derivative products. However a clearing house is needed to settle the contract in a neutral location to offset counterparty risk.
Investment banks that offer this product usually take a riskless position by hedging the client's position with the underlying asset. For example, the client may trade a swap – say Vodafone. The bank credits the client with 1,000 Vodafone at GBP1.45. The bank pays the return on this investment to the client, but also buys the stock in the same quantity for its own trading book (1,000 Vodafone at GBP1.45). Any equity-leg return paid to or due from the client is offset against realised profit or loss on its own investment in the underlying asset. The bank makes its money through commissions, interest spreads and dividend rake-off (paying the client less of the dividend than it receives itself). It may also use the hedge position stock (1,000 Vodafone in this example) as part of a funding transaction such as stock lending, repo or as collateral for a loan.
Parties may agree to make periodic payments or a single payment at the maturity of the swap ("bullet" swap).