A swap is a contract between two parties to exchange cash flows or other financial instruments. Swaps are often used in securitisations to manage risk or to provide additional credit enhancement.
There are many different types of swaps that can be used in securitisations. Some of the most common types of swaps include:
- Interest rate swaps: Interest rate swaps are used to exchange interest payments on different types of debt securities. For example, an issuer of a securitisation may use an interest rate swap to exchange floating-rate payments for fixed-rate payments. This can help to reduce the interest rate risk of the securitisation.
- Currency swaps: Currency swaps are used to exchange payments in different currencies. For example, an issuer of a securitisation that has originated loans in a foreign currency may use a currency swap to exchange payments in the foreign currency for payments in the local currency. This can help to reduce the currency risk of the securitisation.
- Credit default swaps: Credit default swaps are used to transfer the credit risk of an asset from one party to another. For example, an issuer of a securitisation may use a credit default swap to transfer the credit risk of the underlying assets to a third party. This can help to reduce the credit risk of the securitisation.
A swap is sometimes referred to as a "switch" or a "derivative".
Here are some of the applications of swaps in securitisation:
- To manage risk: Swaps can be used to manage a variety of risks in securitisations, including interest rate risk, currency risk, and credit risk. This can help to reduce the volatility of the securitisation and to protect investors from losses.
- To provide credit enhancement: Swaps can be used to provide additional credit enhancement to a securitisation. This can make the securitisation more attractive to investors and can help to reduce the cost of borrowing for the issuer.
- To create new products: Swaps can be used to create new securitisation products that meet the needs of different investors. For example, swaps can be used to create securitisations that are exposed to different types of risk or that have different maturities.
It is important to note that swaps are complex financial instruments and there are a number of risks associated with them. Investors should carefully understand the risks before using swaps in securitisations.