ARREARS SWAP Meaning and
Definition
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An arrears swap refers to a financial derivative contract that allows the exchange of interest rate payments on an underlying debt instrument between two parties, based on the instrument's history of payments. It provides a mechanism for transferring the cash flows associated with arrears or overdue interest payments on a debt to another party.
In an arrears swap, one party is typically the holder of debt in arrears, while the other party is a speculator or investor willing to assume the risk associated with these overdue payments. The swap allows the holder of the debt to transfer the risk of potentially unrecoverable arrears to the counterparty, reducing their exposure to credit risk.
The arrears swap transaction is structured in a way that interest payments are exchanged based on the cumulative interest that remains unpaid, rather than being based on the original contractual interest rate. The swap contract specifies the terms of the exchange, including the calculation methodology for arrears interest payments, the payment frequency, and the agreed-upon spread or fee.
Arrears swaps are commonly used in the financial markets, especially in the realm of fixed-income securities, as a tool for managing credit and interest rate risk. They provide flexibility for market participants to mitigate the impact of unexpected arrears and ensure a more predictable cash flow stream. However, they also involve complex financial arrangements and must be carefully monitored to manage potential counterparty and market risks.
Etymology of ARREARS SWAP
The etymology of the term "arrears swap" stems from the combination of two words: "arrears" and "swap".
- Arrears: The word "arrears" originated from Middle English and Old French. Its root can be traced back to the late Latin word "arrerare", which means "to bring up to date". In the financial context, "arrears" refers to the unpaid or overdue amount of a debt or obligation.
- Swap: The term "swap" has its origins in the Middle English word "swappen", meaning "to strike, strike hands, exchange". It is derived from the Old Norse word "sveppa", which means "to sweep or strike".
