If, for instance, Long-Term wanted to earn the return on $100 million of CBS stock over a three-year period, it would strike a “swap” contract with, say, Swiss Bank. Long-Term would agree to make a fixed annual payment, calculated as an interest rate on $100 million. And Swiss Bank would agree to pay Long-Term whatever profit would have been earned had Long-Term actually purchased the stock. (If the stock fell, Long-Term would pay Swiss Bank.) Most likely, Swiss Bank would hedge its risk by buying actual shares.
