Swap, in the context of finance and trading, refers to the exchange of financial instruments or cash flows between two parties. Swaps are commonly used to manage risk, hedge positions, or alter the cash flow characteristics of an investment.
In the foreign exchange (forex) market, a swap typically refers to the overnight interest rate differential between two currencies in a currency pair. When a trader holds a position overnight in the forex market, they may either receive or pay a swap depending on the interest rate differential between the two currencies involved in the trade.
If the interest rate of the currency being bought is higher than the interest rate of the currency being sold, the trader will typically earn a swap, also known as a positive swap or rollover. Conversely, if the interest rate of the currency being bought is lower than the interest rate of the currency being sold, the trader will usually pay a swap, also known as a negative swap or rollover.
Swaps can also refer to other types of financial transactions, such as interest rate swaps, currency swaps, commodity swaps, and equity swaps. These involve the exchange of cash flows based on predetermined terms, such as fixed or floating interest rates, exchange rates, or commodity prices.
Overall, swaps play a crucial role in managing risk, optimizing investment returns, and facilitating financial transactions in various markets around the world.
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