Commodity swap
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A commodity swap is a type of swap agreement whereby a floating (or market or spot) price based on an underlying commodity is traded for a fixed price over a specified period.[1]
A Commodity swap is similar to a fixed-floating interest rate swap. The difference is that in an interest rate swap, the floating leg is based on standard interest rates such as LIBOR, EURIBOR etc. However, in a commodity swap the floating leg is based on the price of underlying commodity like oil, sugar etc. No Commodities are exchanged during the trade. In this swap, the user of a commodity would secure a maximum price and agree to pay a financial institution this fixed price. Then in return, the user would get payments based on the market price for the commodity involved. On the other side, a producer wishes to fix his income and would agree to pay the market price to a financial institution, in return for receiving fixed payments for the commodity.
The vast majority of commodity swaps involve oil.[2] Many airline and rail companies enter oil commodity swap deals in order to secure lower oil costs in the long term.
References
- ^ "Understanding Derivatives: Markets and Infrastructure". Federal Reserve Bank of Chicago, Financial Markets Group.
- ^ "Commodity Swap". Capital. Retrieved 6 July 2018.
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