What is Commodity Swap

Before defining commodity swap, first one should know the meaning of swap; swap refers to an agreement between two parties to exchange series of payments on predetermined terms. Commodity swap refers to an agreement between two parties under which the cash flows which need to be exchanged are dependent on the price of the underlying commodity. Underlying commodity can be anything from base metal to agricultural produce, crude and other metals.

Commodity swap are used by the companies in order to hedge against the rising prices of commodities, so for example if a company has steel as its raw material, but if the prices of steel are very volatile then the company can go for commodity swap where it agrees to receive payment linked to steel prices and pays a fixed rate in exchange to the other party.

Commodity swap can also be used by the producer of commodity. So if producer is not sure about the revenue which he or she can get from his or her produce due to fluctuation in the commodity price then producer can go for commodity swap where the producer will agree to pay the market price to a financial institution in return for receiving fixed payments for the commodity.

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