Derivatives
Swaps
Interest Rate · Currency · Credit Default · Equity · Total Return
What is a Swap?
Interest Rate Swaps
Currency Swaps
Credit Default Swaps
Equity & TRS
India & RBI
Cash Flow Visualiser
Interview Q&A
Why This Matters Today
The global swaps market exceeds $700 trillion in notional value — larger than all stock markets combined. Every major Indian bank, corporation, and the RBI itself uses swaps. SOFR replaced LIBOR in 2023, reshaping how trillions of dollars in contracts are priced.
What is a Swap?
A swap is a private contract between two parties to exchange cash flows over a period of time. Unlike options or futures traded on exchanges, most swaps are OTC (over-the-counter) — negotiated directly between parties, usually with a bank as intermediary.
The key idea: both parties believe the exchange benefits them. One party wants certainty (fixed payments), the other is willing to take risk for potential savings (floating payments). Neither is speculating on the other — they have different needs.
Types of Swaps
Interest Rate Swap (IRS) — Fixed vs floating interest payments
Currency Swap — Exchange principal and interest in different currencies
Credit Default Swap (CDS) — Insurance against default of a borrower
Equity Swap — Exchange equity returns for fixed/floating rate
Total Return Swap (TRS) — All economic exposure of an asset without owning it
Key Swap Terminology
Notional Principal — The face value used to calculate payments. Not actually exchanged in IRS.
Fixed Leg — The party paying a predetermined fixed rate throughout the contract.
Floating Leg — The party paying a rate that resets periodically (SOFR, MIBOR, etc.)
Tenor — Duration of the swap. Common: 1Y, 2Y, 5Y, 10Y.
Net Settlement — Only the difference between the two legs is paid, not both gross amounts.
Why This Matters Today
Indian companies with floating rate loans (linked to MIBOR or repo rate) actively use IRS to convert to fixed. As RBI cut rates in 2025, companies that locked fixed rates earlier are now reassessing their swap books.
Interest Rate Swaps (IRS)
An IRS is the most common swap. Two parties exchange interest payments on a notional amount — one pays a fixed rate, the other pays a floating rate (linked to a benchmark like MIBOR or SOFR). No principal is exchanged — only the interest differential.
Real World Example — Indian Company
Company ABorrowed ₹100 crore at MIBOR + 1% (currently ~8.5%). Wants certainty — budgeting is hard with floating rates.
BankAgrees to receive MIBOR + 1% from Company A and pay fixed 9% in return.
ResultCompany A now effectively pays fixed 9% regardless of where MIBOR goes. Risk transferred to bank.
If MIBOR risesCompany A benefits — bank pays more floating, company still pays 9% fixed.
If MIBOR fallsBank benefits — company still pays 9% but floating has dropped below that.
SOFR Replaced LIBOR — Why It Matters
LIBOR (London Interbank Offered Rate) was the global benchmark for floating rates for decades — used in $350 trillion of contracts. In 2012, it emerged that major banks had been manipulating LIBOR submissions. The scandal led to its abolition.
SOFR (Secured Overnight Financing Rate) replaced USD LIBOR in June 2023. It's based on actual overnight repo transactions — harder to manipulate. In India, MIBOR (Mumbai Interbank Offered Rate) is the domestic benchmark, now transitioning to a reformed overnight rate.
Why This Matters Today
RBI entered a $5 billion USD/INR swap with banks in 2024 to inject rupee liquidity. Indian IT companies with USD revenues and INR costs use currency swaps to manage forex exposure every quarter.
Currency Swaps
A currency swap involves exchanging principal and interest payments in one currency for principal and interest in another. Unlike IRS, principal is usually exchanged at the start and re-exchanged at maturity. Used by multinationals to raise cheaper debt in foreign markets.
Example — Indian Company Raising USD Debt
ProblemIndian company needs USD 10M. USD borrowing rate for them: 7%. INR borrowing rate: 9%.
US CompanyUS company needs INR but can borrow USD cheaply at 5%. INR borrowing for them: 11%.
SwapIndian company borrows INR, US company borrows USD. They swap the proceeds and service each other's debt.
GainBoth borrow in their home market where they have advantage, then swap. Both save ~2% vs borrowing directly in foreign currency.
Why This Matters Today
CDS on Adani group bonds spiked in early 2023 after the Hindenburg report. CDS are one of the fastest real-time indicators of perceived default risk — often more accurate than credit ratings.
Credit Default Swaps (CDS)
A CDS is essentially insurance against a borrower defaulting. The protection buyer pays a periodic premium (the CDS spread). The protection seller receives that premium and pays out if the reference entity defaults. The 2008 financial crisis was triggered partly by unregulated CDS on mortgage bonds.
How CDS Works
Protection BuyerOwns bonds of Company X. Pays 150 bps/year to insure against default.
Protection SellerReceives 150 bps/year premium. Must pay face value if Company X defaults.
Credit EventBankruptcy, failure to pay, restructuring. Triggers the payout.
CDS SpreadHigher spread = market perceives higher default risk. Sovereign CDS spreads indicate country risk.
CDS and the 2008 Crisis
Banks packaged subprime mortgages into bonds (CDOs) and sold CDS on them — often without holding capital against potential payouts. When mortgage defaults cascaded, CDS sellers like AIG could not pay. The US government bailed out AIG for $182 billion. Post-2008, CDS are now centrally cleared through CCPs to reduce counterparty risk.
Why This Matters Today
Archegos Capital collapsed in 2021 because it held massive undisclosed equity positions through Total Return Swaps. Banks had no idea of the total exposure until it unwound — causing $10 billion in losses across Credit Suisse, Nomura, and others.
Equity Swaps & Total Return Swaps
Equity Swap
One party pays the return on an equity index or stock. The other pays a fixed or floating rate. Used by fund managers to get equity exposure without owning the stock — no stamp duty, no voting rights, but full economic exposure. Common in index replication and synthetic ETFs.
Total Return Swap (TRS)
The total return receiver gets all the economic benefits of an asset — price appreciation plus dividends — without owning it. The total return payer (usually a bank) receives a fixed or floating rate. This is how hedge funds use leverage without appearing on balance sheets.
TRS Cash Flows:
Fund → pays SOFR + spread to Bank
Bank → pays (Nifty return + dividends) to Fund
If Nifty falls → Fund pays the loss to Bank
Why This Matters Today
RBI's swap window directly controls rupee liquidity. When RBI conducts a USD/INR buy-sell swap, it injects rupees now and absorbs them later — a monetary policy tool most retail investors don't know exists.
Swaps in India — RBI & Markets
RBI's USD/INR Swap
RBI uses forex swaps to manage domestic liquidity. In a buy-sell swap, RBI buys USD from banks (selling rupees) and agrees to sell USD back at a future date. This injects rupee liquidity into the system — an alternative to traditional OMOs (open market operations).
OIS — Overnight Index Swap
India's most liquid swap market. One party pays a fixed rate, the other pays the compounded overnight MIBOR rate. OIS rates are closely watched because they reflect market expectations of RBI's repo rate path. When OIS rates fall below the repo rate, the market is pricing in rate cuts.
1Y OIS rate < Repo Rate → Market expects RBI to cut rates
1Y OIS rate > Repo Rate → Market expects RBI to hike rates
Who Uses Swaps in India?
Public Sector Banks
Use IRS to manage interest rate risk on loan books vs. deposit costs
IT & Export Companies
Use currency swaps to hedge USD receivables against INR costs
Infrastructure Companies
Convert floating rate project debt to fixed using long-tenor IRS
RBI
USD/INR swaps to manage forex reserves and rupee liquidity
IRS Cash Flow Visualiser
See how fixed and floating payments flow between two parties over the life of an Interest Rate Swap.
Swaps Interview Q&A
Click any question to reveal the answer
