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Module 3 · Lesson 4 of 6

Swaps and Other Derivatives

A swap is an agreement to exchange streams of payments over time. Swaps are the largest part of the OTC derivatives world, and understanding them also clears up why the word 'swap' appears on a retail trading statement.

Intermediate6 min readLast reviewed 26 October 2026

Written by The Gold Desk editorial team. Not reviewed by a regulated financial adviser. Educational content, not financial advice.

Risk warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Educational content only. Nothing here is a recommendation, and no result is guaranteed.

Module lessons and contents

After this lesson you will be able to

  • Explain how a swap works and what notional amount means.
  • Work through an interest rate swap with numbers.
  • Describe currency swaps, credit default swaps and commodity swaps in plain English.
  • Separate the swaps used by institutions from the overnight swap charge on a retail account.

What a swap is

A swap is a contract in which two parties agree to exchange payments on set dates for a set period. Each payment is calculated from a formula that depends on something such as an interest rate, an exchange rate or a commodity price.

Think of two neighbours. One has a mortgage whose payments rise and fall with the central bank rate and wants certainty. The other has a fixed-rate mortgage and expects rates to fall. If they could agree to cover each other's payments, each would get the type of payment they prefer. Swaps do this in a formal way between companies, banks and governments.

Three terms matter.

  • Notional amount: the reference sum used to calculate payments. In most swaps it is never actually exchanged.
  • Fixed leg: the payments calculated using a fixed rate.
  • Floating leg: the payments calculated using a rate that resets, for example a benchmark short-term interest rate.

Swaps are OTC contracts, so they are tailored and carry counterparty risk, as described in What Are Derivatives?. In practice they are used mostly by institutions, not individual traders.

Key idea

A swap does not usually move the large notional amount. Only the difference between the two payment streams changes hands, which is why a large swap can be settled with a small payment.

The interest rate swap, step by step

The interest rate swap is the most common type. It lets a borrower turn a floating-rate loan into a fixed-rate one, or the reverse.

Worked example: fixing a loan cost (hypothetical numbers)

A company has a £10,000,000 loan that charges the floating benchmark rate. It worries rates will rise. It enters a swap in which it pays 4% fixed and receives the floating rate on a notional of £10,000,000. Settle once a year.

Year 1: floating rate resets at 4.5%.

  1. Loan interest paid to the lender = 4.5% x £10,000,000 = £450,000.
  2. Swap: company receives 4.5% x £10,000,000 = £450,000 and pays 4% x £10,000,000 = £400,000. Net receipt = £50,000.
  3. Total cost = £450,000 (loan) - £50,000 (net swap receipt) = £400,000, which is 4%.

Year 2: floating rate resets at 3.2%.

  1. Loan interest = 3.2% x £10,000,000 = £320,000.
  2. Swap: receives £320,000, pays £400,000. Net payment = £80,000.
  3. Total cost = £320,000 + £80,000 = £400,000, again 4%.

The company's cost is fixed at 4% in both years. In year 2 it would have been cheaper not to hedge, but the aim was certainty, not guessing the rate.

The counterparty, often a bank, has the opposite position. It gained in year 2 and lost in year 1. One person's certainty is another's open risk, and the bank prices that into the fixed rate it offers.

Currency, credit and commodity swaps

Currency swaps

In a currency swap, two parties exchange principal and interest in different currencies. A UK firm needing dollars and a US-based firm needing pounds can swap borrowings. Unlike most interest rate swaps, the principal is often actually exchanged at the start and handed back at the end at the same agreed exchange rate. A related short-term product, the FX swap, pairs a spot currency trade with an opposite forward trade and is widely used by banks to manage funding.

Example (hypothetical): at the start, £8,000,000 is swapped for $10,000,000 at an agreed rate of 1.25 (8,000,000 x 1.25 = 10,000,000). At the end the same amounts are swapped back, whatever the market rate is by then. Interest is paid in between in each currency.

Credit default swaps (CDS)

A credit default swap works like insurance against a borrower failing to repay. The protection buyer pays a regular premium. If the borrower defaults, the seller pays compensation.

Worked example: a CDS (hypothetical numbers)

An investor holds £5,000,000 of bonds issued by a company. They buy protection at an annual premium of 2% of the notional.

  1. Annual cost = 2% x £5,000,000 = £100,000.
  2. If the company defaults and the bonds are only worth 40% of face value, the loss on the bonds is 60% x £5,000,000 = £3,000,000.
  3. The CDS seller pays that £3,000,000, covering the shortfall (in a simple version of the contract).

If no default happens, the investor has paid £100,000 a year for protection they never used, like unused insurance.

Commodity swaps

A commodity swap exchanges a fixed price for a floating commodity price on a set quantity. An airline might pay a fixed price for fuel and receive a floating market price so that its fuel cost is predictable. The same structure can be built for gold or silver.

Other derivatives you may come across

ProductWhat it isKey point
WarrantA long-dated option-like instrument, often issued by a company or bankCan lose all value; issuer risk applies
Spread betA UK product where you bet an amount per point of price movementBehaves like a CFD in risk; tax treatment differs, check with a qualified professional
Structured productA bundled product that combines a bond with a derivativeOften complex; read the terms and fees carefully
Exchange-traded note or fund with gold exposureA listed product that tracks a priceSome are backed by real metal, some use derivatives; check how it is built

Complex products sometimes look simple on the front page. A good habit is to ask three questions before going near anything unfamiliar: what exactly do I own or owe, who is on the other side, and what is the worst thing that could happen?

Warning

If you cannot explain a product to a friend in a few sentences, you are not ready to trade it. Complexity is where hidden costs and unexpected losses live.

Why the word 'swap' appears on a trading account

Here is a point that confuses many new traders. On a retail trading platform, swap usually means the overnight financing charge or credit applied if you keep a position open past the daily cut-off time. It is a cost or small payment linked to interest rates, not a swap in the institutional sense described above.

The idea behind it is related, though. Holding a leveraged position overnight is like borrowing money to hold it, and the rate difference between the two sides of a currency pair, or the cost of funding the position, produces a daily charge or credit.

Worked example: a daily swap charge (hypothetical numbers)

Suppose a broker charges an annual financing rate of 7% on a long position with a notional value of £20,000.

  1. Annual charge = 7% x £20,000 = £1,400.
  2. Daily charge = £1,400 / 365, which is about £3.84 per night.
  3. Held for 10 nights = about £38.40 (some brokers charge triple on one night a week, so the real figure can differ).

Rates and rules vary by broker and product, so always read the financing terms. For the forex version, see Swaps, Rollover and Carry, and for how it applies to gold CFDs see CFDs Explained.

Why this matters for a trader

Institutional swaps shape interest rates, currency markets and credit conditions that in turn move gold, so you benefit from knowing they exist. And on your own account, the daily financing charge is a real cost that can quietly eat into a position held for weeks.

Key takeaways

  • A swap is an agreement to exchange payment streams, usually based on a notional amount that is not itself exchanged.
  • An interest rate swap can turn a floating-rate loan into a fixed-rate cost, giving certainty rather than a profit.
  • Currency, credit default and commodity swaps follow the same exchange-of-payments idea for different risks.
  • Warrants, spread bets and structured products are other derivatives; complexity and issuer or broker risk matter.
  • The 'swap' on a retail trading account is an overnight financing charge or credit, not an institutional swap.

Test yourself

Frequently asked questions

Can a retail trader trade interest rate swaps?

Not in the way banks and companies do. These are mostly institutional OTC contracts. Retail traders usually deal in products such as CFDs.

Is the swap charge on my account always a cost?

No. Depending on the product, direction and rates, it can be a small credit. Brokers also add a markup, so it is more often a cost than a credit. Check your broker's terms.

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