Definition: An asset swap is a type of derivative transaction in which one party exchanges a particular asset for another to improve its position at the expense of the original party.
An asset swap is generally used by companies in the financial industry or businesses that want to raise capital. It involves the buyer making an offer to the seller of an asset for cash. The seller then makes an offer to the buyer for the same asset, and the process continues until all parties have accepted the offer. An asset swap can also be used for security purposes when banks swap commercial paper for securities. It involves an agreement between two parties that if one of them breaches a promise they’ve made, both will pick up the price of the breach.
Asset swap is a type of securities short position in which a seller agrees to buy (or temporarily raise) an asset from a buyer later at a specified price. Large institutions such as banks and brokerage firms typically use asset swaps to offset short positions held against specific target securities. The short positions may be held for trade purposes or speculative purposes. Still, in either case, an asset swap is distinct from a forward or futures contract where the trader expects to receive a specified delivery from the seller at a specific time and under specified conditions.
In an asset swap, a seller offers to give you cash and takes delivery of a particular asset (book, house, whatever) at a specified price plus a profit premium. In return, you sell your asset to them at a higher price and receive cash flows from the sale of this asset (rent from the house, for example) plus a profit premium. If the seller overestimates the value of your asset while you underestimate it, you lose money; if they underestimate it, you may make money. Asset swap is a contract between two parties where one or more may offer to exchange an existing asset for another. This may be done to either buy back the asset at a lower price or receive cash flows from the sale, allowing the seller to cover their debts and buy new assets.
The swap is a short-term loan. At the end of the swap period, the coupons on the underlying assets are paid off, and the floating rate on the swap becomes zero. However, coupon payments and cash payments underlying the swap are not eliminated. Instead, when you take out the swap, you create cash available to you at any time, even if you don’t use it right away. So it’s not as if you are effectively getting rid of cash, which you could have spent on something else.
Asset swap is also known as credit protection or bankruptcy swap. Essentially, it’s a contract in which one party agrees to buy another party’s debt from the market. They then swap the assets and pay off the debt over a set period.