Gibraltar: What Is A Swap?

Last Updated: 19 May 2011
Article by Aaron Payas

Characteristics of a swap

There is a mystique which surrounds swap contracts due to lack of knowledge or available information. By explaining the basics of swaps, including how they work and what their purpose is, I hope this will help to clarify them.

A swap is an agreement between two parties to exchange a series of future cash flows. Swaps are financial instruments that fall under the general umbrella of financial derivatives. Other types of derivatives are forward agreements, futures and options (calls and puts). Most swaps are over-the-counter instruments; this means that they are customised to the requirements of the counterparties to the swap. A swap can be viewed as the exchange of one loan for another. A standard loan will have interest and principal repayment terms and the interest is based on either a fixed or floating rate. The three most common types of swaps are interest rate swaps, currency swaps and equity swaps.

Interest rate swaps

An interest rate swap involves two parties and a set notional value. One party will pay the other a fixed rate of interest on the notional value and the other will pay back a floating rate of interest on the notional value. As both sets of payments are in the same currency, the notional value is not swapped and only the interest payments are made. Furthermore, the interest payments due by each party are netted so only the net interest is paid by the party who owes it.


Party A agrees to pay Party B a fixed rate of 5%.

Party B agrees to pay Party A a floating rate of 12-month LIBOR + 2%.

The payments will be made annually and will be based on a notional amount of £10,000,000.

At the end of the first year, 12-month LIBOR is quoted at 4%.

At that point, Party A owes Party B (£10,000,000)x(0.05) = £500,000.

Party B owes Party A (£10,000,000)x(0.06) = £600,000.

Since only the net interest is paid, only one payment will be made. In this case, Party B will pay Party A, £600,000 - £500,000 = £100,000.


An interest rate swap agreement allows a party to hedge against risk. Let us take a hypothetical case of a company which has borrowed €10mm from a large institution. The interest payments in this loan have been set at LIBOR + 3%. The company now has interest rate risk arising from an increase in LIBOR. The company can hedge against this risk by entering into an interest rate swap. The company can enter into a swap with the same notional value as the initial loan and the same repayment dates. For example, the company shall pay the swap counterparty a fixed rate on a €10mm swap and the counterparty will pay the company a floating rate of LIBOR on the €10mm. By offsetting the variable (LIBOR) on the first loan with the payments it will receive from the swap, the company has effectively converted its €10mm floating rate loan into a fixed rate loan. The company is now completely hedged against the movements of LIBOR.

Currency swaps

Currency swaps work in a similar manner to interest rate swaps. However, in a currency swap both parties will make payments in different currency on different notional amounts. Therefore, the full notional amounts and interest payments are made and are not netted.


Party A borrows £10,000,000 from Party B and agrees to pay annual interest at 5% and pay back the borrowed amount after 3 years.

Party B borrows €10,000,000 from Party A and agrees to pay annual interest at 4% and pay back the borrowed amount after 3 years.

Party A will make repayments in £. Party B will make repayments in €.


A party would look to enter into a currency swap in order to get a better deal on borrowing in a currency in which it does not normally deal in. For example, a US firm looking to set up a branch in Europe will need to borrow in Euros in order to pay for all the start up costs. Since the US firm has no business in Europe or Euros, it will not be able to borrow at a competitive rate so it enters into a currency swap with a European firm which needs to, for some reason, borrow US dollars. The interest rates agreed to between both firms will be better than those that could be obtained by each firm if they were to borrow direct from a bank.

Equity swaps

An equity swap is similar to an interest rate swap. The distinction is that at least one of the parties will make payments based on the return on a stock or a stock index. In an equity swap, floating payments can be made by both parties.

Party A agrees to pay Party B a fixed rate of 3%.

Party B agrees to pay Party A a floating rate based on the return of the index S&P 500.

The payments will be made annually and will be based on a notional amount of £1,000,000.

At the end of the first year, the S&P 500 has appreciated by 5%.

At that point, Party A owes Party B (£1,000,000)x(0.03) = £30,000.

Party B owes Party A (£1,000,000)x(0.05) = £50,000.

Since the payments are in the same currency, only the net interest is paid. Therefore, Party B will pay Party A, £50,000 - £30,000 = £20,000.


An investor may enter into an equity swap to protect capital gains, to avoid the sale of the underlying stock or stock index for tax reasons or in order to hedge against the volatility of the underlying stock or stock index.

Termination of a swap

There are four ways to terminate a swap prior to the termination date embedded in the swap contract. A swap contract may be terminated by mutual termination, by entering into an offsetting swap contract, by resale or by using what is called a swaption. A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap.

If you would like further information please contact the author Aaron Payas.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.