Applied risk management series: OTC commodity swaps valuation, hedging and trading

In this article, Carlos Blanco and Michael Pierce provide an overview of swap instruments and discuss the pricing, valuation, hedging and risk management of over-the-counter commodity swaps. They also comment on the expected ramifications of new regulations for end-users and swap dealers

In a fixed-for-floating swap, two parties agree to exchange the difference between a floating price and a fixed price, multiplied by a negotiated notional amount for one or more settlement periods. Single-settlement swaps are also referred to as ‘forwards’ by many market participants. Swaps are financially settled, which means that the parties meet their contractual obligations by cash transfers.

When a hedger enters into an over-the-counter swap, they receive compensation when the market moves