We all know that commodities are basically numerous physical assets which include things like base metals, energy stores, food or any other type of product who has a value that can be retained in time. The commodity swaps make it easy for the consumers as well as producers alike to hedge the commodity prices.
Usually, the credit default swap is made in cash, but there are multiple situations in which the physical delivery is really common. Most of the time, the floating leg is held by the commodity consumer that is willing to pay the fixed rate for that particular commodity as long as the price remains guaranteed. Swap rates for the commodity swaps are fixed by estimating the commodity price. They can also be fixed with the help of commodity futures as well.
As expected, you have two different types of commodity swaps, and these come either in the form of commodity for an interest rate derivative or fixed floating commodity swaps.
The fixed floating commodity swaps are usually similar to the interest rate with a fixed or floating swap, although in this particular situation both of these legs are commodity based, so they are used by the ones who created the commodity, as well as the consumers to lock the price of the commodity so no other changes will intervene.
On the other hand, the commodity for interest swaps is quite similar to the equity swaps. In them, a total return of the commodity will be exchanged with the money market rate.
In order to successfully determine the value of the swap claims, the current value of the cash flows in the each transaction leg will have to be found as well. The value of the swap is calculated, as well as the cash flows, the fixed legs for the commodity or even the commodity for the interest swap, which might include present values and some eligible discount factors.
If you want to value a commodity swap then you need to take multiple things into account. These include the cost of hedging, the liquidity of the commodity market, the brokerage fees, credit risks, capital costs, administrative costs as well as the variability of the futures bid/offer spread.
Moreover, you need to be aware that many of these factors will be extended to the hedging and pricing of the swaps.
In the end, the commodity swaps can prove to be really useful for people that trade commodities in the derivative market, so if you are such a company it would be quite recommended to perform them.