What is the main function of swaps in financial contexts?

Swaps primarily serve the function of exchanging payment streams between parties. In financial contexts, swaps allow two parties to enter into an agreement where they exchange cash flows based on different financial instruments, often involving interest rates or currencies. This mechanism enables entities to manage risk and optimize their financial positions according to their specific needs.

For example, in an interest rate swap, one party may pay a fixed interest rate while receiving a variable rate, allowing them to hedge against fluctuations in interest rates. This ability to convert cash flow structures helps companies and investors tailor their exposure to various types of risk, such as interest rate risk or foreign exchange risk, thereby enhancing their financial strategies.

While creating investment portfolios, ensuring fixed asset prices, and reducing tax liabilities are relevant financial activities, they do not encapsulate the primary role of swaps. Swaps fundamentally hinge on the exchange of payment streams to achieve more favorable financial outcomes or risk profiles, making this the correct choice.