can someone shed some background on how and why swap spreads are used in pricing bonds?
I think you are refering to a float/fixed swap on variable rate bank debt. To have an apples to apples comparison to compare bank debt to treasuries or other fixed pay securities, the floating rate needs to be converted to a fixed rate. This is a CFA text book float to fixed conversion equation.
no i don’t think so. a memo i’m reading on pricing bonds says “we analyzed these bonds in terms of their market spreads to swaps. swap spreads are typically used to price investment grade bonds.”
IG is often looked at on a Libor (swap) basis. Its another benchmark aside from USTs. One might say that GE 5.625 18 is trading (mid mkt) +435/10yr or L+335. It’s just another way to look at a bond. You could of course compare this to floaters and look to swap out the cash flows as well. Some feel the swap curve is a better benchmark because you have less in the way of anomalies due to premium/discount coupons in UST.
Also, back in the good old days, swaps spreads were looked at as a barometer of risk and/or as a double-A rated financial. So, you could think of spreads as an incremental amount of risk above that. Less applicable now with CDS. To be quite honest with you, i dont remember more academic reasons why people use swaps, which is kind of lame of me.
excellent. thank you.
I thought the other reason is that swaps cover more distinct points of the maturity curve than on-the-run Treasuries which are limited to 2, 5, and 10
yeah, that too… but, you can bench to the UST “curve” which sometimes people do with stuff like 7 yr corp bonds, before they “roll” to the 5yr. But yeah, that is a very good point.
if you use leverage, then more applicable to use swap curve as you borrow on a floating rate.
My friends from europe tend to quote spreads to the swap curve. Stateside it seems spread to UST is more common. I once found a paper that found that, in the US, though spreads were usually quoted to UST, traders actually treated them more like swap spreads. Go figure. (I unfortunately can’t find that paper now – spend enough time with Google Scholar and you will.) Anyway, here’s some useful basics (from a pair of guys apparently – “Lehman Brothers” ?): http://www.classiccmp.org/transputer/finengineer/[Lehman%20Brothers,%20O’Kane]%20Credit%20Spreads%20Explained.pdf “Credit investors need a measure to determine how much they are being paid to compensate them for assuming the credit risk embedded within a security. A number of such measures exist, and are commonly known as credit spreads since they attempt to measure the return of the credit asset relative to some higher credit quality benchmark. Each has its own strengths and weaknesses. In this article, we define, describe and analyse the main credit spreads for fixed rate bonds1, floating rate notes and the credit default swap.”
one rationale in the textbooks is they are not regulated by governments, so they represent prices closer to the market. does that make sense?
storko Wrote: ------------------------------------------------------- > one rationale in the textbooks is they are not > regulated by governments, so they represent prices > closer to the market. > does that make sense? I can’t think of any significant bond markets where the govt “regulates” the yield curve. Can you?
i moved from sell-side to buy-side and i’d almost never heard of spread vs. swaps (basically spread to libor)… seem to use it alot with european credits. not in canada or u.s. much as far as i can see (obviously you can make reference to something any way you want). bear in mind though that libor isn’t a risk-free rate. it’s a proxy for bank risk… and similarly, the swap spread has been considered a proxy for the credit/liquidity risk of a moderately strong bank.
DarienHacker Wrote: ------------------------------------------------------- > storko Wrote: > -------------------------------------------------- > ----- > > one rationale in the textbooks is they are not > > regulated by governments, so they represent > prices > > closer to the market. > > does that make sense? > > > I can’t think of any significant bond markets > where the govt “regulates” the yield curve. Can > you? Well, I guess I don’t know about regulate, but taxation, auction rules, rules about things like strippability, supply of different tenors, supply in general all affect the yield curve and some small set of people can change those rules.
libor/swap curve represents a funding cost, so more intuitively useful to measure the spread you earn above that?? you cannot borrow at the treasury rate after all.
unless you were at the 30 year point of the swap curve which went as low as negative 8 bps to the 30 yr bond last week.
rohufish Wrote: ------------------------------------------------------- > you cannot borrow at the > treasury rate after all. Unless you work for that Henry Paulson guy running that hedge fund, I can’t remember what it’s called.
yeah, that makes sense that borrowers like to talk LIBOR as they don’t borrow from banks in “Treasury”… but of course institutional bond managers invest in treasuries so it makes sense. i feel like i’m having a brain freeze but what is the base rate for a large U.S. corporation when they borrow from their banks? or is it often simply a fixed rate??
LIBOR + credit spread