Editing Equity swap (section)

==Applications==
Typically equity swaps are entered into in order to avoid transaction costs (including Tax), to avoid locally based dividend taxes, limitations on leverage (notably the US margin regime) or to get around rules governing the particular type of investment that an institution can hold.

Equity swaps also provide the following benefits over plain vanilla equity investing:

* An investor in a physical holding of shares loses possession on the shares once he sells his position. However, using an equity swap the investor can pass on the negative returns on equity position without losing the possession of the shares and hence voting rights.
:For example, let's say A holds 100 shares of a Petroleum Company. As the price of crude falls the investor believes the stock would start giving him negative returns in the short run. However, his holding gives him a strategic voting right in the board which he does not want to lose. Hence, he enters into an equity swap deal wherein he agrees to pay Party B the return on his shares against LIBOR+25{{Not a typo|bps}} on a notional amt. If A is proven right, he will get money from B on account of the negative return on the stock as well as LIBOR+25{{Not a typo|bps}} on the notional. Hence, he mitigates the negative returns on the stock without losing on voting rights.

* It allows an investor to receive the return on a security which is listed in such a market where he cannot invest due to legal issues.
:For example, let's say A wants to invest in company X listed in Country C. However, A is not allowed to invest in Country C due to capital control regulations. He can however, enter into a contract with B, who is a resident of C, and ask him to buy the shares of company X and provide him with the return on share X and he agrees to pay him a fixed / floating rate of return.

Equity swaps, if effectively used, can make investment barriers vanish and help an investor create leverage similar to those seen in derivative products. However a clearing house is needed to settle the contract in a neutral location to offset counterparty risk.

Investment banks that offer this product usually take a riskless position by [[Hedge (finance)|hedging]] the client's position with the underlying asset.  For example, the client may trade a swap – say Vodafone.  The bank credits the client with 1,000 Vodafone at GBP1.45.  The bank pays the return on this investment to the client, but also buys the stock in the same quantity for its own trading book (1,000 Vodafone at GBP1.45).  Any equity-leg return paid to or due from the client is offset against realised profit or loss on its own investment in the underlying asset.  The bank makes its money through commissions, interest spreads and dividend rake-off (paying the client less of the dividend than it receives itself). It may also use the hedge position stock (1,000 Vodafone in this example) as part of a funding transaction such as stock lending, repo or as collateral for a loan.