 in this section i will explain swap contracts and the pricing of swap contracts till now we were talking about financial futures now we are talking about swap so swap contracts only the major difference is that multiple clash flows are happening so this is why we call it swap contracts so swap contracts are basically are also the derivative instruments derivative contracts or derivative instruments and in this we are talking about swaps they are also the agreements or the contracts between any two parties which agrees series of cash flows over a specified period of time and another benefit of swaps is that they have a lot of flexibility in their design and overall the contracts are structured based upon the mutual agreements the requirements of participating parties and the participation concern of participating parties you make flexible agreements in which more than one cash flows are happening over a certain period of time and this derivative agreement is also happening but instead of one cash flow or multiple cash flows that is why we call such contracts swaps now there is another important thing which we need to understand and that is the pricing of a swap contract when we apply the price of a swap contract for any financial instrument then what are the things that are kept in mind this is what we are going to understand in this section so suppose as an example we are taking suppose we have a yen dollar swap i.e. you are trying to swap in yen and dollars so in this example we are assuming that the contract is of 2 years and the notional principle is 100 million yen so remember this so now we have to account for the pricing that 100 million yen transaction is going to happen and you are going to deal with the yen dollar now we have seen the exchange rate from the market so we have seen that one year forward price of the yen is dollar 0.01 and the forward price of 2 years is dollar 0.01 0.0104 so there is a slight increase in the price of the yen so you can see that after 0.01 there is a 0.04 which is the time period of 2 years so you will get a slight increase in the price now first year we have said that if you get 1 million dollars then after 2 years the exchange rate we have accounted for it will be 1.04 million dollars now when we are talking about currency swap so in that we will apply single swap exchange rate we cannot apply multiple exchange rates because we are signing a swap contract so for that we have to look at the formula which is used to find out the price of the swap contract and here we go now we have said that the rate of our swap it is being represented by this capital F and in this we have to account for this is 1 million divided by 1.08 plus 1.04 million divided by 1.08 because it is the value of the second year so we have divided it by 1.08 to raise to the power 2 and where did it come from? this is the risk less dollar interest rate per year so we have said that the risk less rate of return that is 8% so we have accounted for it first year we have put 1.08 so for the second year we have divided it to raise to the power 2 now we have defined that the value of the business transaction that is the value of the swap contract that is 100 million yen so you have counted this 100 million yen multiplied by F F is the swap rate which we are interested in finding out and you have to multiply this 1 divided by 1.08 plus 1 divided by 1.08 and we are taking the value of the second year so we have put a square on it if we solve this particular equation for this capital F which is the swap rate you will be able to find out this value and this will be the swap rate for this particular example where you are going to sign the swap contract of the second year so your swap rate should be this this is how we can find out this rate using the formula which we have just discussed