For a better understanding what a swap advisor does, here are a few of the most common financial terms and their definitions that we reference on our website.
Definition of Derivative
A derivative is a broad term covering a variety of financial instruments whose values are derived from one or more underlying assets, market securities or indices. In practice, it is a contract between two parties that specifies conditions (especially the dates, resulting values and definitions of the underlying variables, the parties’ contractual obligations, and the notional amount) under which payments are to be made between the parties. The most common underlying assets include: commodities, stocks, bonds, interest rates and currencies.
Definition of Hedge
A hedge is an investment position intended to offset potential losses/gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses/gains suffered by an individual or an organization. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products, and futures contracts.
Definition of a Swap
In finance, a swap is a derivative in which counter-parties exchange cash flows of one party’s financial instrument for those of the other party’s financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (or coupon) payments associated with the bonds. Specifically, the two counter-parties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated. Usually at the time when the contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as an interest rate, foreign exchange rate, equity price or commodity price.
Definition of ‘Unwind’
To close out a position that has offsetting investments or the correction of an error. Unwinds occur when, for example, a broker mistakenly sells part of a position when an investor wanted to add to it. The broker would have to unwind the transaction by selling the erroneously purchased stock and buying the proper stock. Generally, the term “unwind” refers to more complicated and layered trades.
Explanation of ‘Unwind’
One type of investing that features unwind trading is arbitrage investing. If, for the sake of illustration, an investor takes a long position in stocks, while at the same time selling puts on the same issue, he or she will need to unwind those trades at some point. Of course, this entails covering the options and selling the underlying stock. A similar process would be followed by a broker attempting to correct a buying/selling error.