What Is a Stock Swap?

Stock swap refers to the signing of swap agreements between the two parties of the transaction, stipulating that within a certain period of time Party A shall periodically pay Party B a return based on a certain nominal principal and linked to a stock index. Party B also periodically pays Party A a fixed or floating interest rate return based on equivalent nominal principal, or a return linked to another stock index.

Stock swap

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Stock swaps are the product of the further development of stock-derived financial instruments and one of the most important innovations in the financial market over the past two decades. Although its popularity is not comparable to interest rate swaps and currency swaps, and the scale of transactions is not as good as other derivatives of stocks such as stock index futures and stock options, but its irreplaceable unique functions are recognized by investors. There are the following aspects:

Stock swap for assets

The most basic function of stock swaps is to be able to transform assets, and traders do not need to actually purchase such assets. In a popular stock swap, investor A holding fixed income securities and investor B holding a stock index exchange asset returns. In this way, A gets the return of the stock portfolio and B gets the return of the fixed income securities. Both of them realize the conversion of assets at the same time, and they do not need to change the original asset portfolio, so they do not have to pay the relevant transaction costs. From another perspective, stock swaps help investors easily cross the stock market and the fixed income bond market. When a stock holder expects the stock price to fall, he can obtain a return on fixed income bonds through a stock swap, which is equivalent to selling fixed income securities to buy fixed income securities; when fixed income bond holders expect stocks When the price will rise, he can obtain the stock index return through the stock swap, which is equivalent to selling bonds and investing funds in a certain stock portfolio. Both parties are no longer constrained by their market position, and get a return in the other market. More importantly, they do not need to actually convert their assets, thereby greatly reducing transaction costs and eliminating the need to sell assets. Incurred capital gains tax. By the same token, a trader can also use a stock swap to convert the stock portfolio he holds into a floating-rate asset, or another stock portfolio, or a single stock.

Stock swap management risk

Stock swaps are also an extremely convenient tool for managing risk. In the popular stock swap, the trader converts the return of the stock index into the return of a fixed interest rate, actually avoiding the risk of stock price fluctuations and locking in the return on investment. Especially when the investor estimates that the stock price will decline in the long term and wants to maintain the original stock portfolio, the stock index is exchanged for a fixed interest rate, so that not only can the stable interest rate be obtained at each settlement. Return. When the stock index changes negatively, the investor can still get the loss of the stock index paid by the swap counterparty. Of course, the investor will also face a certain risk, that is, when the stock index changes more than a fixed interest rate, he will suffer a certain loss. In addition, investors can also convert the risk of stock price fluctuations into floating interest rate risk through the swap of stock indexes for floating interest rates. Investors holding a certain stock can also convert the risk of a single stock into the overall risk of the stock portfolio through the exchange of a single stock index, thereby diversifying the non-systematic risk without holding multiple stocks.

Stock swap cross-border investment

The stock swap can not only realize the span between the stock market and the bond market, but also the span between the domestic market and the foreign market. By using fixed or floating interest rates for foreign stock index swaps, investors only need to pay returns linked to fixed or floating interest rates to obtain returns on foreign stock portfolios, which is equivalent to determining the principal amount invested in stock portfolios in foreign markets. Investors will not be subject to any controls in foreign markets, and a series of tedious procedures and transaction costs for purchasing foreign stocks will be avoided. Therefore, stock swaps are generally welcomed by overseas investors. In addition, stock swaps can also have the function of avoiding currency risks. Equity swaps with different currencies can choose whether to avoid currency risk. If investors are willing to accept currency risk, the return of foreign stock index will be based on the nominal principal denominated in foreign currency; if investors choose to avoid currency risk, then foreign stock index The return will be based on the nominal principal denominated in local currency.