A swap is an agreement to "swap" periodic fixed interest payments with floating interest payments. This kind of contract enables one to swap fixed liabilities into floating, and may be used to reflect your view of the market.

The swap market offers a variety of advantages. It has almost no government regulations, making it more comparable across different markets; some sovereign issues offer a variety of tax benefits to domestic and/or foreign investors, making government curve comparative analysis across countries latently inconsistent. In many countries there is simply no liquid government bond market with maturities longer than 1 year. The swap market is an increasingly liquid market, with narrow bid-ask spreads and a wide spectrum of maturities. The supply of swaps is solely dependent on the number of counterparties wishing to transact at any given time. No position in an underlying asset is required, avoiding any potential repo specials effects.

The swap rate is the interest rate for the fixed-rate leg of an interest rate swap. The swap curve is the swap's equivalent of a yield curve. It identifies the relationship between swap rates at varying maturities. Used in similar manner as a bond yield curve, the swap curve helps to identify different characteristics of the swap rate versus time.

Calculate Swap Rate

A par swap rate is the rate on the fixed leg of a "vanilla" interest rate swap for the relevant maturity. Spot rates, swap rates and discount factors can all be determined from each other.

Let s(T) stand for the swap rate at time T.

Example

Let r(1) = 5%, r(2) = 5.5%, r(3) = 6% and r(4) = 6.5%.

For T = 1,

Therefore, s(1) = 5%.

For T = 2,

Therefore, s(2) = 5.49%.

For T = 3,

Therefore, s(3) = 5.97%.

Swap prices are frequently quoted as a spread over government issues, therefore serving as a rough indicator of credit and liquidity components of a bond's yield to maturity. A swap spread is the difference between the fixed rate on an interest rate swap contract and the yield on a on-the-run government bond with an equivalent tenor. It is usually, but not always, positive. Risk increases as the swap spread widens.

The swap spread is based on a bond's yield to maturity. The Z spread uses the zero-coupon yield curve instead. It is the constant basis point that would need to be added to the implied spot yield curve such that the discounted cash flows of a bond are equal to its current market price. It is a purely theoretical concept designed to allow a bond yield to be compared to a swap rate as fairly as possible.

The TED spread is the difference between the interest rates on interbank loans and on T-bills. It is an indicator of perceived credit risk in the general economy, since T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks.

The LIBOR-OIS spread is the difference between LIBOR and OIS rates. It is considered to be a measure of risk and liquidity in the money market. A higher spread is typically interpreted as indication of a decreased willingness to lend by major banks.