An agreement between two parties to exchange a series of future cash flows is called:

Question

Accepted Answer

The correct option is 3:
A **Swap** is a derivative contract specifically designed for two parties to exchange, or "swap," two different streams of future cash flows over a predetermined period. This contractual agreement precisely fits the definition provided, as it involves an exchange of a *series* of payments. The most common types are interest rate swaps, where one party pays a fixed interest rate while receiving a floating rate, and currency swaps, where principal and interest in one currency are exchanged for principal and interest in another. Swaps are critical instruments in financial markets, primarily used by corporations and financial institutions for managing or speculating on interest rate and foreign exchange risk by altering their exposure to these variables.

The incorrect option is 1:
A **Contract** is the overarching, generic legal term for any legally enforceable agreement between two or more parties. While a swap, a bill of exchange, and a promissory note are all legally binding contracts, the term "Contract" itself is too general. It does not provide the specific financial context or defining characteristic of exchanging future cash flow streams, which is the core subject of the question. Therefore, while technically true in a legal sense, it is not the most accurate or precise financial term for this specific arrangement.

The incorrect option is 2:
A **Bill of exchange** is a form of negotiable instrument, typically used in international trade, which acts as an unconditional order to a party (the drawee) to pay a specified *fixed sum of money* to a third party (the payee) at a fixed or determinable future time. This instrument represents a single, fixed-sum debt obligation. It does not represent an agreement to *exchange a series of different cash flow streams* between two parties, which is the defining feature of a swap.

The incorrect option is 4:
A **Promissory note** is a financial instrument where one party makes an unconditional written promise to pay a specified *fixed sum of money* to the other party (the payee) either on demand or at a specified future date. Like a Bill of exchange, it is primarily a debt instrument representing a debt obligation with set terms for repayment. It concerns a unilateral promise to pay a fixed amount, rather than a bilateral agreement for the ongoing exchange of two varying streams of future cash flows.