Types of Derivatives-Cont’d Swap contracts A swap is an agreement whereby two parties (called counterparties) agree to exchange periodic payments. The cash amount of the payments exchanged is based on some predetermined principal amount, which is called the notional principal amount or simply notional amount. The cash amount each counterparty pays to the other is the agreed-upon periodic rate times the notional amount. The only cash that is exchanged between the parties are the agreed-upon payments, not the notional amount. A swap is an over-the-counter (OTC) contract. Hence, the counterparties to a swap are exposed to counterparty risk. Swap can be decomposed into a package of derivative instruments, e.g. a package of forward contracts.
