A swap is a derivative contract in which two parties agree to exchange financial instruments, cash flows, or obligations over a specified period. Swaps are primarily used for hedging risk and managing financial exposure.
The two most common types are interest rate swaps (exchanging fixed-rate payments for floating-rate payments) and currency swaps (exchanging cash flows in different currencies). For example, Company A with a variable-rate loan might swap with Company B that has a fixed-rate loan, if each prefers the other's terms.
Swaps are widely used by corporations, banks, and financial institutions to manage risk and optimize their financial positions. They are traded over-the-counter (OTC) and customized to meet the specific needs of the parties involved.