What is the exact definition of “swap spread”? The CFAI EOC of Reading 30 is full of it. For example, consider this: 14. An ABC Corporate issue trades at a bid price of 120 bp over the 5-year US Treasury yield of 6% at a time when LIBOR is 5.7%. At the same time, 5 year LIBOR based swap spreads equal 100bp (to the 5 year treasury). A. If a manaer purchased the ABC corp issue and entered into a swap to pay fixed and receive floating, what sprea over LIBOR is realized until the first swap reset date? B. Why would a total return manager buy the issue and then enter into a swap to pay fixed and receive floating? Again, my question is mainly on swap spreads and how to use them. Thanks, OA
Just a short addition: I just found the definition in the glossary: “The difference between the fixed rate on an interest rate swap and the rate on a treasury note with equivalent maturity; it reflects the general level of credit risk in the market”
In finance, swap spread is a popular way to indicate the credit spreads in a market. It is defined as the spread paid by the fixed-rate payer of an interest rate swap over the rate of the on-the-run treasury with the same maturity as the swap. For example, if the fixed-rate of a 5-year swap is 7.26% and the 5-year Treasury is yielding at 6.43%, the swap spread is 7.26% - 6.43% = 83 bps. Swap spread became a popular indication of credit spread in Europe during the 1990s. wikipedia
Dood, I have to ask, but I’m guessing derivatives wasn’t your strong suite in LII?
my thought was you viewed the swap spread the same way you view any other spread measure. If you expect swap spread to narrow, sign of lower credit risk. If you expect to widen, higher credit risk.