Equity Swap

In an equity swap two parties agree to exchange future cash flows linked to the performance of a stock or stock index. One cash flow, or leg, is usually linked to a market interest rate, the other to a stock or stock index performance. For example, party A swaps $10 million at Libor plus 5 basis points for six months with party B who agrees to pay any percentage increase in $10 million invested in the S&P500. In six months party A will owe the interest on the $10 million but this will be offset by the percentage increase in the S&P500 multiplied by $10 million. If the S&P500 falls then party A will owe the percentage fall multiplied by $10 million in addition to the interest payment.