What are swaps and CFDs, and why do they exist?
Two families remain, and they could hardly be less alike in character. One is the invisible plumbing of corporate finance. The other is a retail product that regulators have restricted or banned outright in several major markets.
Swaps — exchanging one kind of cash flow for another
A swap is an agreement to exchange two streams of payments over time. Structurally it is a chain of forwards bundled into one contract.
The dominant example, and the largest derivative category on earth by notional, is the interest rate swap. Take a company that has borrowed $100 million at a floating rate — the reference rate plus 1%. Its interest bill rises every time rates rise, which makes its budget unplannable.
It enters a five-year swap in which it pays 4% fixed and receives the floating reference rate, both on a $100 million notional. Now trace the cash:
- Pays the lender: reference + 1%
- Receives from the swap: reference
- Pays on the swap: 4%
- Net: 5% fixed, whatever the reference rate does.
The floating leg it receives cancels the floating leg it pays. A floating loan has become a fixed one without renegotiating a single line of the loan agreement.
Two details matter enormously. First, the $100 million never changes hands — it exists only to scale the percentages. It is notional, and the next lesson is entirely about why that word is so widely misread. Second, only the difference is actually paid: if the reference averages 5.2% one year, the company receives 5.2% and pays 4.0%, netting +1.2% × $100m = $1.2 million — which is exactly what its higher loan bill cost it. Nobody speculated. This is treasury plumbing, and it is why interest rate derivatives make up the large majority of the world's OTC notional.
CFDs — the same payoff, sold to individuals with leverage
A contract for difference pays the change in price of an underlying between opening and closing, with no delivery of anything. Economically it is a forward with no fixed end date, offered directly to retail customers by a broker, usually with substantial built-in leverage.
The facts about how they are regulated are part of the education, so state them plainly:
- CFDs are not permitted for retail customers in the United States.
- In the EU and UK, regulators intervened in 2018–2019 to impose leverage caps (from 30:1 on major currency pairs down to 2:1 on crypto), negative-balance protection for retail accounts, a ban on bonus incentives, and a mandatory risk warning stating the percentage of that provider's retail accounts that lose money. The UK later went further: since January 2021 the sale of crypto-derivatives, crypto CFDs included, to retail clients has been banned there outright rather than capped.
- When ESMA examined samples of retail CFD accounts ahead of its 2018 measures, it reported that between roughly 74% and 89% of retail accounts lost money. Firms' own mandated disclosures have since commonly sat in the 70s and 80s percent, varying by firm, product mix and period. Those are documented, published population statistics, not warning labels invented for this course.
Nothing here suggests using — or avoiding — such a product. It is stated because a course on derivatives that omitted the loss-rate data would be teaching the mechanics and hiding the record.
The four families in one table
| Family | Right or obligation? | Standardised? | Paid at inception? | Characteristic use |
|---|---|---|---|---|
| Forward | Both sides obliged | Bespoke, OTC | Nothing | Fixing an exact price on an exact date |
| Future | Both sides obliged | Standardised, on-exchange | Margin, not a price | Liquid hedging and exposure |
| Option | Buyer has the right; seller is obliged | Both exchange-traded and OTC exist | A premium | Asymmetric protection or view |
| Swap | Both sides obliged | Mostly OTC, increasingly cleared | Nothing | Converting one cash-flow type into another |
Two axes explain the whole table: obligation versus right, and standardised versus bespoke. Every product you meet in later courses is a combination or a repackaging of these four.
Try it now
- The table below is the upper bound of the Fed's target range on 1 January 2020 and on every day it changed after that, up to 28 September 2026, when it was measured. Find the difference between its lowest and highest level.
| From | Upper bound |
|---|---|
| 2020-01-01 | 1.75% |
| 2020-03-04 | 1.25% |
| 2020-03-16 | 0.25% |
| 2022-03-17 | 0.50% |
| 2022-05-05 | 1.00% |
| 2022-06-16 | 1.75% |
| 2022-07-28 | 2.50% |
| 2022-09-22 | 3.25% |
| 2022-11-03 | 4.00% |
| 2022-12-15 | 4.50% |
| 2023-02-02 | 4.75% |
| 2023-03-23 | 5.00% |
| 2023-05-04 | 5.25% |
| 2023-07-27 | 5.50% |
| 2024-09-19 | 5.00% |
| 2024-11-08 | 4.75% |
| 2024-12-19 | 4.50% |
| 2025-09-18 | 4.25% |
| 2025-10-30 | 4.00% |
| 2025-12-11 | 3.75% |
| 2026-09-17 | 4.00% |
A floating-rate loan does not pay the Fed's rate itself; it pays a market reference rate that trades inside the Fed's range. The latest dollar fixing is below, beside today's range: check where it sits against the two bounds.
- Apply that difference to $100 million of floating-rate borrowing and compute the annual interest swing in dollars. That number is the reason the interest rate swap market exists.
- Find any CFD provider's published risk warning and note the percentage figure it discloses. Write it next to your answer from step 2 — the same underlying idea, two very different populations using it.