Swap spread: Difference between revisions

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==Finance==

The use of the term swap-spreads in financial markets has grown progressively over time. Many economists have deconstructed swap spreads and their implications on the financial markets in order to make investment decisions within the global equity and fixed income markets. The utilization of swap spreads as a tool within the markets has grown substantially since 1994 as mentioned.<ref>https://doi.org/10.1007/s00181-020-01852-0 (Kóbor, Shi, L., & Zelenko, I. (2005)). What determines U.S. swap spreads? World Bank. “Market Voice: A Negative for Swap Spreads.” Refinitiv Perspectives, 5 Jan. 2021</ref> due to the growing understanding of the interrelationship between financial themes. A swap spread is the difference between the fixed component of a given swap and the yield of a debt security. In the US this correlation triggered the emergence of derivative products and contracts as investors looked to exchange fixed interest repayments on their securities for floating rate repayments. Swap spreads as a result emerged as a mechanism to price this transition from fixed to floating rate repayments.<ref name=Lando>Feldhütter, & Lando, D. (2008). Decomposing swap spreads. Journal of Financial Economics, 88(2), 375–405. https://doi.org/10.1016/j.jfineco.2007.07.004</ref>

The Mechanics of a swap spreads (A worked example of an asset swap spread)

Swap spreads have been adopted into the pricing metrics by many financial institutions when they look to assess the value of their assets under management and future business opportunities. At the base level, swap spreads are contracts which allow people to manage their risk in which two parties agree to exchange cash flows between a fixed and floating rate holding. Simply, the swap spread rate = swap rate – yield on a government bond. <ref name=Lando /> The computation of a swap spread has evolved overtime as financial market participants look to use the data to make either short or long decisions within the financial markets.