Reverse Swap

A new swap that undoes the effects of an existing swap (a type of derivative that involves the exchange of cash flow streams). A reverse swap is one of several ways to undo a swap. Other options for undoing a swap are completing a cash settlement based on market value, selling the swap (with permission from the other party) and using a swaption. One reason why a reverse swap would be used instead of simply canceling the original swap is to avoid negative tax or accounting implications.

Swaps are private transactions that are traded over the counter and as such are subject to credit risk. These contracts exchange assets, liabilities, currencies, securities, equity participations and commodities. They are generally used for risk management by institutions and are less common among inpidual investors.

Reverse swaps allow investors to mitigate the original risk that they are exposed to upon entering a swap, or to cancel a position if they feel that market conditions will change in such a way as to give the original swap a negative value.