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Strategic Financial Management · Swaps

Commodity, Equity, Amortising Swaps and Swaptions

Updated 11 October 2026 · Fact-checked

Beyond interest rate and currency swaps, you must know commodity, equity, asset, amortising and accreting swaps. A swaption is an option to enter a swap at a fixed rate on a future date. Swap risks include credit (counterparty) risk and market risk. Answer by defining, giving the cash flow, and stating who uses it.

Understand Other Swaps and Swaptions

A swap is an agreement between two parties to exchange cash flows over a period, based on a notional amount. The notional is usually not exchanged. Only the cash flows linked to it are swapped, often as a net payment.

The type of swap depends on what the cash flows are linked to:

  • Commodity swap: one party pays a fixed price for a commodity, the other pays a floating (market) price. Used by producers and users, such as an airline hedging fuel cost or a metal producer fixing its selling price. Usually settled in cash, with no delivery of the commodity.
  • Equity swap: one party pays a return on a share or index (dividends plus price change), the other pays a fixed or floating interest rate or the return on another index. It gives exposure to equity without buying the shares.
  • Asset swap: usually a fixed-rate bond is swapped into a floating-rate return (or the reverse) by pairing the bond with an interest rate swap. The investor keeps the bond but changes the nature of its income.

The notional can also change over time. In an amortising swap, the notional falls over the life of the swap, matching a loan that is repaid in instalments. In an accreting swap, the notional rises, matching a borrowing that is drawn in stages, such as a project loan. A related type is the roller-coaster swap, where the notional goes up and down.

A swaption is an option on a swap. The buyer pays a premium and gets the right, not the obligation, to enter into a swap at a fixed rate on or before a set date. A payer swaption gives the right to pay fixed and receive floating. A receiver swaption gives the right to receive fixed and pay floating. The seller (writer) must enter the swap if the buyer exercises. The buyer's maximum loss is the premium.

Swaps carry risk. Credit (counterparty) risk is the chance the other party defaults when the swap has positive value to you. Your exposure is the replacement cost, not the notional. Market risk is the loss from movements in interest rates, exchange rates, or commodity or equity prices after the swap is made. Other risks you can mention are liquidity risk, basis risk, legal risk and operational risk.

Key rules to remember

Net swap settlement (fixed vs floating)
Net payment = Notional × (Floating rate − Fixed rate) × Period in years
Positive means the fixed-rate payer receives. Negative means the fixed-rate payer pays. Check which side the question asks about.
Payer swaption exercise rule
Exercise if market swap fixed rate > strike rate
You pay the lower strike rate. Ignore the premium when deciding to exercise; include it when computing net gain.
Receiver swaption exercise rule
Exercise if market swap fixed rate < strike rate
You receive the higher strike rate.
Credit exposure of a swap
Exposure = Maximum of (Replacement value of swap, 0)
Only the party for whom the swap has positive value faces credit loss. The notional is not at risk.
Amortising/accreting swap interest
Interest for a period = Notional outstanding in that period × Rate × Period in years
Use the notional of each period separately.

How to solve Other Swaps and Swaptions questions

Use this approach for both theory and numerical questions on these swaps and swaptions.

  1. 1Identify what the question asks: describe a type, explain a swaption, compare, or compute a payoff.
  2. 2For a type of swap, state what is exchanged, what it is linked to (commodity price, equity return, bond, changing notional) and who uses it.
  3. 3For numerical work, list notional, fixed rate, floating rate and period for each settlement date.
  4. 4Compute each net payment as Notional × rate difference × period fraction, using the notional outstanding in that period.
  5. 5For a swaption, name the type (payer or receiver), strike rate, premium and expiry. Compare strike with the market swap rate on exercise date.
  6. 6Decide whether to exercise, then compute net gain after the premium.
  7. 7For risk questions, name the risk, explain how it arises in a swap and give a mitigant such as collateral, netting, credit limits or a clearing arrangement.
  8. 8End with a short conclusion or recommendation.

Quickest way: Match the swap to the exposure

When to use it: Use for 2-mark MCQs and short-note answers where you must recognise a swap or swaption quickly.

  1. Look at what is being swapped: commodity price means commodity swap; share or index return means equity swap; bond income converted means asset swap.
  2. If the notional falls over time, it is amortising. If it rises, it is accreting.
  3. If the question mentions a right with a premium to enter a swap, it is a swaption. Paying fixed means payer; receiving fixed means receiver.
  4. For risk, ask who can lose: default by the other side is credit risk; price or rate movement is market risk.
  5. In a numerical, work out one net settlement per period and stop.

Common mistakes in Other Swaps and Swaptions

  • Treating the notional as the amount at risk in credit risk.

    The notional is large and appears in every calculation.

    Fix: Say that the notional is a reference amount. Credit loss is limited to the replacement cost or the net amount due.

  • Mixing up amortising and accreting swaps.

    Both sound like changes in size and the terms are similar.

    Fix: Amortising means the notional reduces, like a loan being repaid. Accreting means the notional grows, like a loan being drawn.

  • Confusing payer and receiver swaptions.

    Students link the word to the option holder's action on the floating leg.

    Fix: The name refers to the fixed leg. Payer swaption: pay fixed. Receiver swaption: receive fixed.

  • Forgetting the premium when computing the swaption outcome.

    The exercise decision ignores the premium, so the premium gets dropped altogether.

    Fix: Decide exercise on strike versus market rate, then subtract the premium paid to get the net result.

  • Saying a commodity swap involves physical delivery.

    The commodity is named, so delivery seems natural.

    Fix: State that these are normally settled in cash on the price difference, though physical settlement is possible if agreed.

  • Using the opening notional for every period in an amortising swap.

    Students copy the first period's interest to save time.

    Fix: Write the outstanding notional for each period in a small table before computing interest.

Worked examples

Example 1

A company has a ₹10,00,000 notional amortising swap. It pays a fixed 8% p.a. and receives a floating rate. Notional is ₹10,00,000 in year 1 and ₹6,00,000 in year 2. Floating rate is 9% in year 1 and 7% in year 2. Settlement is annual. Find the net settlement each year for the company.

Show the solution
  1. Year 1: fixed paid = 10,00,000 × 8% = ₹80,000.
  2. Year 1: floating received = 10,00,000 × 9% = ₹90,000.
  3. Year 1 net = 90,000 − 80,000 = ₹10,000 received.
  4. Year 2: fixed paid = 6,00,000 × 8% = ₹48,000.
  5. Year 2: floating received = 6,00,000 × 7% = ₹42,000.
  6. Year 2 net = 42,000 − 48,000 = ₹6,000 paid.

Answer: The company receives ₹10,000 in year 1 and pays ₹6,000 in year 2.

Example 2

A firm buys a payer swaption on a 5-year swap with notional ₹50,00,000, strike fixed rate 7% p.a., for a premium of ₹20,000. At expiry, the market 5-year swap fixed rate is 8.5% p.a. Should the firm exercise? What is the annual saving, and does the total saving over 5 years (ignoring time value) cover the premium?

Show the solution
  1. A payer swaption pays fixed at the strike. Exercise if market rate > strike: 8.5% > 7%, so exercise.
  2. Annual saving = 50,00,000 × (8.5% − 7%) = 50,00,000 × 1.5% = ₹75,000.
  3. Total saving over 5 years = 75,000 × 5 = ₹3,75,000.
  4. Net of premium = 3,75,000 − 20,000 = ₹3,55,000.

Answer: Exercise. The saving is ₹75,000 a year, ₹3,75,000 over 5 years, and ₹3,55,000 after the premium (ignoring time value of money).

Exam tips

  • Define each swap in one line, give the cash flow and name a user. This pattern earns marks in short notes.
  • Draw a small arrow diagram between two parties for any swap description. It takes seconds and clarifies the flows.
  • In numerical questions, show the outstanding notional for each period before computing interest.
  • For risk questions, always separate credit risk from market risk and add a mitigant.
  • In MCQs, read whether the swaption is payer or receiver before checking the rates.

Practice questions from Swaps

Other Swaps and Swaptions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Other Swaps and Swaptions: frequently asked questions

What is a swaption and how does it work?

A swaption is an option to enter a swap at a fixed strike rate on a future date. The buyer pays a premium and may choose whether to exercise. A payer swaption lets you pay fixed; a receiver swaption lets you receive fixed.

What is the difference between amortising and accreting swaps?

In an amortising swap, the notional reduces over time, matching a loan repaid in instalments. In an accreting swap, the notional increases over time, matching a loan drawn in stages.

What is credit risk in a swap?

It is the risk that the counterparty defaults on its payments. The loss is limited to the replacement cost of the swap, not the notional. Collateral, netting and credit limits reduce it.

How do I answer CMA Final theory questions on swaps?

Define the swap, show who pays what, and give a practical use. Add the risks and one way to manage them. Keep each point short and use a simple diagram where useful.