It is developed in the over-the-counter (OTC) market as long-term price risk management instruments. A commodity swap contract (or simply swap) obligates two parties to exchange a floating price for a fixed price (or vice versa) for a given amount of a commodity at specified time intervals. In other words, a swap is an agreement between two parties – the hedger and the hedge provider – in which the hedger (a commodity user or producer) agrees to pay a fixed price and receive a floating price for a specified volume of a commodity over a specified period. In a swap with two parties, there is typically a consumer and a producer of the commodity, and a bank or any other financial institution that acts as an intermediary. Since a swap is a one-time negotiation, no major periodic decisions have to be made and they do not require constant monitoring. Swaps do not involve hassles of exchange-traded brokerage and margin calls; this makes them more convenient tools of price risk management. These are some key factors that make swaps easier tools of risk management for developing countries.
