Planning for your long-term financial stability requires creating a portfolio that diversifies your investments and sets you towards successful, long-term wealth. Whether you are just starting to think about creating your own portfolio, or are considering expanding your pre-existing portfolio, learning more about the Credit Default Swap can be very helpful. In particular, let’s take a closer look at the plain vanilla swap to see exactly what they are, and how you may be able to benefit from them.
In the financial world, the most often used swap is the plain vanilla swap. It is a predefined agreement between two companies with rules strictly determined by both parties at the beginning of the process. Simply put, a plain vanilla swap is when two counter parties exchange their cash flows to make use of other institutions financial instruments. The end result is that both involved save money and increased options when it comes to handling payments.
What Comprises These Agreements?
Everything is set into place before the process begins. A time frame is determined that will dictate how long the agreement will last for. More often then not, two competing interest rates are defined, one fixed and one floating. A currency is decided on. Finally, a principal is discussed and settled on. It is when more factors become defined that a plain vanilla swap becomes something more complicated.
Plain Vanilla Swaps
Types of plain vanilla swaps include the plain vanilla commodity swap, the plain vanilla Interest Rate Swap, and the plain vanilla currency swap. What ties these all together is the lack of complexity and variables that are defined in the use and purpose of the swap.
Say we have two companies, A and B. Both companies are interested in a plain vanilla interest swap. Company A has a fixed interest rate, and is looking to reduce the amount they are paying by getting a floating rate. Company B has a floating interest rate, and is looking for the stability of a fixed interest rate to grow their company. Both companies enter an agreement where they switch their interest rates over the payment of the principal amount. In the end, both companies get what they want, often times saving both companies in the long run. Because there are so many companies on both ends looking to swap their interest rates, plain vanilla interest Swaps are incredibly common.