Equity Swap

An equity swap is a trade of future cash flows between two parties that enables each party to diversify their income for a predetermined amount of time while holding onto their original assets. Similar to an interest rate swap, an equity swap is based on the return of an equity index rather than having one leg be the “fixed” side. According to the conditions of the swap, the two sets of ostensibly equal cash flows are exchanged. An equity-based cash flow, such as that from a stock asset known as the reference equity, may be exchanged for a fixed-income cash flow (such as a benchmark interest rate).

Similar to an interest rate swap, an equity swap is based on the return of an equity index rather than having one leg be the “fixed” side.These swaps are traded over-the-counter and offer a lot of customization. The majority of equity swaps take place between sizable financial institutions such lending institutions, investment banks, and car financiers.

The equities leg frequently uses a prominent stock index, such as the S&P 500, while the reference for the interest rate leg frequently uses LIBOR. Swaps can be highly customized depending on what the two parties agree to and trade over-the-counter. Equity swaps enable big institutions to hedge particular assets or positions in their portfolios in addition to diversification and tax advantages.

Contrary to debt/equity swaps, which are restructuring transactions in which a company’s or an individual’s obligations or debts are exchanged for equity, equity swaps are not to be confused with debt/equity swaps.Equity swaps involve counterparty risk because they are traded over the counter.