Equity Swap
Candlefocus EditorEquity swaps often involve two different parties. First, is the “fixed party” that agrees to receive a fixed payment and then invests in some sort of derivative based on the underlying equity index. Second, is the “varied party” which agrees to make a variable payment, which is the return realized by investing the fixed party's payment in the same underlying index.
In an equity swap, the two participants exchange payments related to the difference in performance of the underlying equity index. This can include payments of both cash and assets. Equity swaps are typically structured as either a zero-coupon rate or a fixed-coupon rate swap. In a zero-coupon rate swap, the cash payments between the two parties will be equal while in a fixed-coupon rate swap, the payments are unequal. The swap typically has a pre-determined maturity date, although some arrangements may allow either party to terminate early. Generally, the termination date gives either party the right to stop making payments and close out the swap.
Equity swaps are issued by large financing firms such as auto financiers, investment banks, and lending institutions. The interest rate leg is often referenced to LIBOR while the equity leg is often referenced to a major stock index such as the S&P 500. The benefits of equity swaps to the investor include the ability to hedge against market risk and to gain access to potential return from overseas markets or other asset classes not easily accessible.
Overall, an equity swap is a flexible, cost-efficient and highly customizable derivative instrument that can be used for hedging and speculation purposes. It provides investors with an avenue to benefit from the potential returns of an underlying equity index without the need to invest in the actual stocks.