Fixed-for-floating swap
Also written Fixed-for-floating commodity swap · Commodity swap · Fixed price payer · Floating price payer
A commodity swap in which one side pays a fixed price agreed at the outset and the other pays a floating price — a spot price, a nearest-futures price, or an average of either — reset each period.
In plain language
A swap is a deal to exchange a series of cash payments over a set period.
In a fixed-for-floating commodity swap the two sides pay on different bases. One side pays a fixed price for the commodity. That price is settled when the swap is signed and never moves. The other side pays the market price, reset period by period.
The workbook names them the fixed price payer and the floating price payer.
Only money moves. Each period the two amounts are worked out, and the difference is paid.
Why do it? A buyer who pays fixed has locked its cost. A seller who receives fixed has locked its revenue. A futures contract does that for one date. A swap does it for many periods in one deal.
Do not confuse it with an interest rate swap. There the floating leg is a rate. Here it is the price of oil or metal.
How it works
The fixed leg is simple: one agreed price, paid every period, settled at the execution of the swap.
The floating leg is where the detail sits. The workbook allows the floating price to be any one of three things:
- a spot price for the specified commodity;
- the price for a specified nearest futures contract for that commodity; or
- an average of those spot prices or futures prices calculated over a period.
The workbook's own illustration is oil. A fixed-for-floating swap on oil with monthly payments may take its floating price as the average of the settlement prices of the first nearby month CME WTI Crude Oil Futures for each day of the relevant month. So the floating leg is not one day's print — it is a month of daily settlement prices, averaged.
Which way each party is exposed is the examinable part, and the workbook sets out all four:
| Party | Indirect exposure to the commodity |
|---|---|
| Fixed price payer | Long |
| Fixed price receiver | Short |
| Floating price payer | Short |
| Floating price receiver | Long |
Read it from the fixed price payer's side. His obligation is frozen at the agreed price. If the commodity gets dearer, he is paying less than the prevailing market price, so the swap increases in value for him. That is a long position in all but name.
One honest gap to record: the workbook gives no notional size, tenor, rate or rupee figure for this product. It teaches the structure and the four exposure directions only, so the numbers in the example below are illustrative rather than the workbook's.
A worked example
Sundar Petrochem Pvt Ltd, Ennore, buys 1,000 barrels of crude-linked feedstock every month and cannot live with the price swings. It enters a 12-month fixed-for-floating commodity swap with a dealer. Sundar is the fixed price payer at Rs 6,800 per barrel. The dealer is the floating price payer, and the floating price for each month is the average of the daily settlement prices of the nearest crude oil futures contract. (Figures illustrative; the workbook gives none.)
| Month | Floating average | Fixed | Net swap cash flow |
|---|---|---|---|
| April | Rs 7,100 | Rs 6,800 | Dealer pays Sundar Rs 3,00,000 |
| May | Rs 6,500 | Rs 6,800 | Sundar pays dealer Rs 3,00,000 |
| June | Rs 6,800 | Rs 6,800 | Nil |
April arithmetic: (7,100 - 6,800) x 1,000 = Rs 3,00,000, received by Sundar.
Now put the physical purchase beside it. In April the refinery actually pays about Rs 7,100 a barrel, or Rs 71,00,000. The Rs 3,00,000 received on the swap pulls the effective cost back to Rs 68,00,000 — Rs 6,800 a barrel. In May the physical bill is only Rs 65,00,000, but Sundar pays Rs 3,00,000 away on the swap, so the effective cost is again Rs 68,00,000.
That is the whole point. Sundar has not made money and has not lost money on price. It has stopped caring what crude does — which is precisely the long exposure the workbook attributes to a fixed price payer.
Why NISM asks about it
Chapter 1 (Introduction to Commodity Markets), section 1.2.2, which introduces swaps as one of the commodity derivative products alongside forwards, futures and options, and names the fixed-for-floating swap as the commonly used commodity swap.
Three question shapes come out of this half page. Who makes periodic payments based on a price agreed at the execution of the swap — the fixed price payer. What may the floating price be — a spot price, the price of a specified nearest futures contract, or an average of either over a period; a clean three-item list is a gift to an examiner. And the exposure question: a fixed price payer indirectly has a ____ exposure on the underlying commodity — long.
Common exam traps
- The fixed price payer is indirectly LONG, not short. He gains when prices rise, because his own payment is frozen. Candidates see the word payer and answer short.
- The floating price payer is indirectly short, and the floating price receiver is long. Four combinations, and the workbook lists all four. Learn them as two mirrored pairs.
- The floating price is not always a spot price. It may be a nearest-month futures price, or an average of either over a period. Only one of the three options is the spot price.
- This is not an interest rate swap. The vocabulary is identical — fixed leg, floating leg — but here the floating leg is a commodity price and no interest rate appears anywhere.
- Both legs are periodic payments. The workbook defines a swap as an agreement to exchange a series of cash payments; what is fixed or floating is the price, not a delivery schedule.
- The oil illustration uses the average of daily settlement prices across the month, not the month-end price. An average and a closing price are different numbers, and the workbook chose the average.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Forward contractA bilateral, over-the-counter agreement between two parties to buy or sell an asset on a fixed future date at a price agreed today — customised to suit them, and binding on both.
- Futures contractA standardised forward traded on an exchange, where the exchange fixes every term except the price and the clearing corporation guarantees settlement, so neither side carries the other's default risk.
- Interest rate swapAn agreement to exchange streams of interest payments on a notional principal for a set period — typically fixed against floating — where only the net difference ever changes hands.
- Cost of carryThe cost of holding an asset until a future date — financing interest plus storage, less any income it pays. It links spot to futures: fair futures price = spot + cost of carry − inflows.
- SwapA derivative in which two parties agree to a specified exchange on future dates — typically one pays a fixed interest rate and receives a floating one on an agreed principal that never itself changes hands.
- Naturally longThe position every business holds in its finished goods — it gains when their prices rise and loses when they fall, which is why finished goods are hedged by selling futures.
- Naturally shortThe position every business holds in its raw materials — it must buy them in future, so a price rise hurts it exactly as a short position would, and a long hedge cancels the exposure.