What Is an Asset Swap?

An asset swap is a derivative contract where two parties exchange fixed and floating assets. Floating assets continually change in quantity or value. Most swaps involve cash flows based on a 澳洲幸运5开奖号码历史查询:notional principal amount and an actual asset exchange.

Swaps do not trade on exchanges, and retail investors do not generally engage in swaps. Rather, swaps are 澳洲幸运5开奖号码历史查询:over-the-counter (O🤡TC) contracts between businesses or financial institutions.

Asset Swap Process

Asset swaps hedge currency, credit, or interest rate risks. Asset swaps overlay the fixed interest rates of bond coupons with floating rates. An investor acquires a bond position and then enters an 澳洲幸运5开奖号码历史查询:interest rate swap with the bank that sold them the bond.

The swap or protection buyer purchases a bond from the swap or protection seller, paying a "澳洲幸运5开奖号码历史查询:dirty price." This price equals the par value of the bond plus its accrued interest. The buyer enters a contract to pay the seller fixed coupon payments equal to those received from the bond. The seller agrees to give the buyer a floating rate payment based on a benchmark plus or minus a fixed spread. 

The maturity of this swap is the same as the maturity of the asset. The swap buyer is essentially buying protection and the swap seller is also selling that protection. In the event of default, the swap buyer will continue to receive payments plus or minus the spread f🦩rom the swap seller.

Calculating Spread

An asset swap spread is the difference between the bond's yield and the corresponding swap rate. It represents the premium or discount the bondholder receives or pays relative to the swap rate. This spread is commonly expressed in basis points.

• Bond Yield: The discount rate where the present value of a bond's cash flows equals the bond's market price.
• Swap Rate: The fixed rate in the swap contract where the value of the fixed leg equals the value of the floating leg.
  
  

Example of an Asset Swap

Suppose a business buys a bond at a dirty price of 110% and wants to hedge the risk of a default by the bond issuer. The bond's fixed coupons are 6% of the par value. The swap rate is 5%. Assume that the investor has to pay a 0.5% price premium during the swap's lifetime. The asset swap spread is 0.5% (6% - 5% - 0.5%). Hence the bank pays the business SOFR rates plus 0.5% during the swap's lifetime.

The Bottom Line

An asset swap is a derivative contract between two parties that exchange fixed and floating assets. The transactions are completed OTC based on terms agreed upon by the buyer and seller﷽.

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