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    A Quick Guide To Asset Swaps: What Is An Asset Swap? What Are The Advantages of Asset Swaps?

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    Damian Walężak
    Asset swap

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    A Quick Guide To Asset Swaps: What Is An Asset Swap? What Are The Advantages of Asset Swaps?

    Uploaded by

    Damian Walężak
    129 views1 page
    Asset swap

    Original Title

    Asset Swaps

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    Asset swap

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    129 views1 page

    A Quick Guide To Asset Swaps: What Is An Asset Swap? What Are The Advantages of Asset Swaps?

    Uploaded by

    Damian Walężak
    Asset swap

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 1

    A quick guide to asset swaps

    What is an asset swap? What are the advantages of asset swaps?


    Asset swaps normally involve an investor buying a fixed coupon The main advantage for the investor is yield pick up; for investors
    bond and at the same time entering into an interest rate swap that who want to hold the asset to maturity the asset swap can offer an
    has a maturity equal to that of the bond. attractive return compared with similar vanilla floating rate notes
    and credit derivatives.
    The investor uses the coupon received from the bond to pay fixed
    interest on the swap. The swap counterparty then pays a floating What are the disadvantages of asset swaps?
    rate of interest to the investor. The fixed rate investment has been
    There are no free lunches. If the asset swap provides you with an
    converted into a synthetic floating rate note, (FRN), see the
    attractive return it is because you are taking risk.
    diagram below:

    The main risk you will be taking is credit exposure on the bond.
    There is also a potential future credit exposure on the swap.
    Bond
    If you want to sell the asset swap before maturity the transaction
    Fixed interest costs of selling an illiquid bond and canceling the IRS can also be
    relatively high.
    Fixed interest
    Finding bonds that offer attractive asset swap returns can be
    Investor Swap difficult. In as asset hungry market it has become difficult to find
    suitable investments. This is one of the reasons why credit default
    Floating interest swaps and structured credit trades have become popular.
    How does it work?
    If the fixed interest the investor pays on the swap exceeds the If the asset swap is placed in a banking portfolio and not marked-
    current market swap rate then the floating interest rate payment to-market the investor can end up holding a credit impaired asset
    received by the investor from the swap counterparty will be without realising it.
    greater than Libor. (Normally this is expressed as Libor plus a
    number of basis points). How do you value an asset swap?
    Marking-to-market the bond and the swap will not avoid credit risk
    Why can the investor pay a relatively high rate on the swap? but it will highlight any deterioration in the creditworthiness of the
    Because the bond coupons that are used to make the swap bond. The mark-to-market of the asset swap package comprises
    payments are higher than the swap rate. two items:

    This means that only bonds that have a yield or return that is 1. The market price of the bond
    greater than the swap rate will give the investor a return that
    exceeds Libor. Bonds that have a yield below the swap rate will 2. The net present value of the associated swap
    provide returns beneath Libor.
    Any change in value of the bond due to changing interest rates will
    Who does this and why? be reflected by an equal and opposite change in the value of the
    Financial institutions are major investors in asset swaps. The assets swap. Any change in the credit spread of the bond will remain
    can take the form of securities or loans. The main reason for unhedged. If the credit spread of the bond improves there will be a
    creating the synthetic structure is to reduce interest rate risk. It also net profit, if it deteriorates there will be a net loss.
    suits the funding profile of banks.

    Banks fund themselves short term, it is cheaper. This means that


    the Libor receipt on the swap matches the short term funding cost.
    If the asset swap return is above Libor the bank will make a profit.
    It is this that attracts many buyers.

    What is a par/par structure?


    Par/par asset swaps are asset swap packages where the investor
    pays 100%, (par), for the bond and on maturity receives back
    100%, (par). Suppose a bond trades at 99.50% including accrued
    interest, the investor pays 100% to the structuring bank. 99.50%
    is used for the bond purchase and 0.50% goes to the swap William Webster
    counterparty as an up-front payment. Barbican Consulting Limited
    Financial Markets Training
    The swap counterparty uses this 0.50% to increase the Libor
    margin paid to the investor over the life of the swap. The investor
    [email protected]
    pays par and receives a return based on a par. 00 44 (0)20 79209128

    www.barbicanconsulting.co.uk Copyright © 2006 by BCL All rights reserved

    Financial Markets Training

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