It stands for pay-as-you-go swap; an inflation swap where the two counterparties exchange an inflation rate against a fixed rate every year. This swap is usually used to hedge issues of index-linked bonds. Put it another way, one counterparty pays an index-linked coupon, which is a fixed rate leg plus the annual rate of change in the underlying index, and receives Euribor/ LIBOR, plus a specific spread, if any.

This swap is also referred to as a year-on-year inflation swap.

It also stands for pay-as-you-go CDS. A credit default swap (CDS) transaction which has as underlying a bond such as an asset-back security (ABS) or a residential mortgage backed security (RMBS). The protection seller compensates the protection buyer over the life of the swap for any cash flow shortfalls in terms of interest or principal payments. This swap is cash flow driven, not single event driven as in regular credit default swaps traded by private companies.

PAUG may also denote pay-as-you-go option (PAUG option). It is a non-standard option in which the premium is paid monthly or quarterly over its life. Furthermore, this option gives the holder the right to stop making installment payments. In case that happened, the option will automatically be terminated on the date a payment is first missed. Insofar as the net present value of remaining installments is less than the option’s value, it is improper to still make any more payments. This option allows an investor, against a bit more premium, to limit losses arising from a good-turned-bad investment position. For non-American-style options (European options for instance), it is sometimes in the interest of an option holder to continue making payments if a pay-as-you-go option still has a positive net present value on a payment due date.