In derivative trading, there is a kind of contract known as a "swap." Here's an oversimplified definition: these deals involve people (well, usually they involve financial institutions, but banks are people too, right?) trading something that they eventually plan on trading back. Essentially, they are trading use of a thing, but not the thing itself.
Think of it like mutual borrowing. Saying to a friend "hey, let me borrow your car today and I'll let you watch a movie on my high-tech home theater system." This is a swap. You and your friend get use of each other's stuff for limited period of time.
Don't feel bad if that all hasn't sunk in. The derivatives market itself can get somewhat confusing, and swaps possibly represent the most confusing part. But for defining this term, the key for a swap is that there is a time limit. An expiration.
But sometimes these swaps get ended earlier than expected. Say something comes up that interrupts operation of one of the items in a swap, like a bankruptcy or a merger. Because of the early termination, one side owes the other side something as compensation.
In the example we discussed, you borrowed your friend's car, as you guys agreed, but while driving around you get a call: "hey, the power went out. I can't watch the movie." You got to use the car, but your friend didn't get their movie. You need to come up with something else to give them.
The Agreement Value Method is one of the ways to figure out what's owed when a swap ends early. (And an obviously dangerous one, because when two parties just agree on some value of an esoteric property, there is a kind of confusion-liability embedded in that agreement, as it's likely that, down the line, somebody will feel screwed.) Specifically, the International Swaps and Derivatives Association has three approved methods for figuring out termination payments when a swap ends prematurely. The Agreement Value Method is the most common one. (The others, by the way, consist of the Indemnification Method and the Formula Method, but we won't go into those here.)
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Finance: What is a swap, and what is a s...41 Views
Finance allah shmoop what is a swap And what is
a swap Shin Um can we just say it's an
option to swap You know like microsoft is a micro
computer software thing or like the electrocution is electricity and
execution or the bromance is you know brother and romance
which is something totally different when dealing with gerbils Anyway
one day a guy was holding a swap turned a
corner wasn't looking where he was going then glam o
he ran into an option What came of it was
a super hybrid type of security were in a slop
like i swap you so many dollars for so many
euros is tacked onto an option You want the ability
to pay off your loan either in us dollars or
in euros assuming they still exist when your loan comes
due That whole brexit thing that issue have the option
to swap the flavor of payments you're making for the
hundred grand You borrowed no it's houses play out well
When the bond was issued one dollar bought you one
euro and the interest rate was eight percent So you
paid eight grand a year to rent that hundred for
ten years at which point you're going to pay it
all off simple but after five years the exchange rates
have drifted massively Magic fairy dust was sprinkled by wizards
all over europe They beat back the thirty two hour
work week Corruption unions and economic misery wrought by not
being able to compete with china russia in africa and
now amazingly the euro is a much stronger currency than
the u s dollar that's kind of a fictional story
here that we'll make enough In fact one euro buys
you two u s dollars like it when the euro
was first put out there So if you holding the
swap shin on the interest payment flavor of the hundred
grand you borrowed if you so choose you can pay
that eight grand in euros that is instead of the
eight thousand dollars a year in interest you can pay
for thousand euros It's almost a ziff your interest rate
was cut in half That's not really it's a value
is the same it's just the number of units were
cut have theirs You know that works And if you
live in europe and work in europe and we're paid
in euros Well it really is like a roman holiday
of interest rates of just want to focus on the
numbers But the values of the same there's No free 00:02:15.938 --> [endTime] lunch here even in swap shen lang
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