When it comes to financial instruments, there are a lot of options available to investors and traders. Two of the most popular types of swaps are interest rate swaps and credit default swaps. But what's the difference between these two types of swaps? Let's take a closer look.
An interest rate swap is a type of derivative contract in which two parties agree to exchange periodic payments, based on different interest rate indices. The most common type of interest rate swap is the plain vanilla swap, in which two parties exchange a fixed rate for a floating rate, or vice versa. Interest rate swaps can be used to hedge against interest rate risk, or to speculate on changes in interest rates.
A credit default swap is a type of derivative contract in which one party agrees to pay the other party a periodic payment in exchange for protection against a credit event. A credit event can be anything from a company defaulting on its debt payments to a sovereign default. Credit default swaps can be used to hedge against credit risk, or to speculate on the probability of a credit event.
So, what's the difference between an interest rate swap and a credit default swap? The main difference is the underlying asset. An interest rate swap is a derivative contract based on interest rates, while a credit default swap is a derivative contract based on credit events. Another key difference is the use of the contracts. Interest rate swaps are typically used to hedge against interest rate risk, while credit default swaps are typically used to hedge against credit risk.