Differences between Swaps, Forwards and Futures (2024)

FAQs

Differences between Swaps, Forwards and Futures? ›

A Swap contract compares best to a Forward contract, although a Forward has only a single payment at maturity while a Swap typically involves a series of payments in the futures. In fact, a single-period Swap is equivalent to one Forward contract.

Swaps: Involve the continuous exchange of cash flows between counterparties over the life of the swap. One party pays a fixed interest rate, while the other pays a floating rate. FRAs: A single, lump-sum payment is made at maturity based on the difference between the contract rate and prevailing market rate.

A forward contract is a private, customizable agreement that settles at the end of the agreement and is traded over the counter (OTC). A futures contract has standardized terms and is traded on an exchange, where prices are settled daily until the end of the contract.

An FX swap is suitable for a party requiring the base currency at a future date. An FX forward is ideal for a party seeking to hedge its currency exposure. It can last several years, depending on the agreement between both parties.

Swaps involve the exchange of cash flows based on the difference in commodity prices, whereas futures and options involve the buying and selling of the underlying commodity at a predetermined price on a future date.

A swap is a derivative contract through which two parties exchange the cash flows or liabilities from two different financial instruments. A forward swap delays the start date of the obligations agreed to in a swap agreement made at some prior point in time. 1. Forward swaps can, theoretically, include multiple swaps.

In the previous chapter, we introduced two simple kinds of generic swaps: interest rate and currency swaps. These are usually known as “plain vanilla” deals because the structures of these swaps are simple and more or less similar, except for the contract details. These constitute a large part of derivatives trading.

A future's expiration date is standardized. Forwards mature upon the delivery of the underlying asset (e.g., such commodities as corn or oil). Even though futures are standardized and have preset maturity dates, they entail that the delivery of the underlying asset may never happen.

Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. Buying forward is when a commodity is purchased at a price negotiated today for delivery or use at a future date.

Is a swap a future? ›

A futures contract has one expiration date. A swap contract has periodic cash flows, where the fixed and floating leg are paid/received. N.B.: Post 2010, both futures and swaps are marked to market daily and collateral is collected to cover the risk.

Practical Example

Party A is Canadian and needs EUR. Party B is European and needs CAD. The parties enter into a foreign exchange swap today with a maturity of six months. They agree to swap 1,000,000 EUR, or equivalently 1,500,000 CAD at the spot rate of 1.5 EUR/CAD.

Recall that a swap is a derivative contract between two counterparties to exchange a series of future cash flows. In comparison, a forward contract is also an agreement between two counterparties to exchange a single cash flow at a later date.

One key difference between swaps and futures, however, is that futures are highly standardized contracts, while swaps can be customized to better hedge the price risk of the commodity for the counterparty.

Both swaps and futures have certain daily oversight and management requirements. The day-to-day management of futures positions requires the appropriate level of technology and resources to enable mark-to-market pricing and effective risk control.

A futures contract is economically similar to a forward contract. The two main differences are: A swap is usually more practical for long-term hedging as futures contracts seldom have much liquidity beyond the first few delivery times. For simple or short-term hedging this doesn't matter much.

The swap rate is the fixed interest rate demanded by the receiver of a swap to exchange the uncertain floating rate payments over time. The forward curve shows the market's forecast of future floating interest rates. The swap rate curve or swap curve is a par curve showing swap rates over all the available maturities.

Interest Rate Swaps (IRS) and Forward Rate Agreements (FRA) are forward contracts in which two counterparties exchange periodically, and for a predefined period of time, flows derived from interest rates, but not the principal or notional amount. One counterparty pays the flow while the other receives it.

The general swap can also be seen as a series of forward contracts through which two parties exchange financial instruments, resulting in a common series of exchange dates and two streams of instruments, the legs of the swap.