Advantages and Disadvantages of Swaps

Swap is an instrument used for the exchange of stream of cash flows to reduce risk.

The advantages of swaps are as follows:

1) Swap is generally cheaper. There is no upfront premium and it reduces transactions costs.

2) Swap can be used to hedge risk, and long time period hedge is possible.

3) It provides flexible and maintains informational advantages.

4) It has longer term than futures or options. Swaps will run for years, whereas forwards and futures are for the relatively short term.

5) Using swaps can give companies a better match between their liabilities and revenues.

The disadvantages of swaps are:

1) Early termination of swap before maturity may incur a breakage cost.

2) Lack of liquidity.

3) It is subject to default risk.

* Next: Advantages and Disadvantages of Forwards
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