Asset-swap - recognized as a combination of an interest rate swap, (an agreement of two parties, which states that both of them decide on exchanging sequence of interest payments)  and a cash bond. The objective of this consolidation is to alter the interest-rate basis of the mentioned bond. The consequence of this, leaves the bondholder paying a fixed coupon, and receiving a floating coupon (a spread over LIBOR - the London Interbank Offered Rate, which serves as a globally acceppted key benchmark). This coupon is referred to as the asset-swap spread, a function of the credit risk of the bond over, as well as the above interbank credit risk. It's value consists of the difference between a bond's market price and par, along with, the difference between a bond coupon and swap fixed rate .
There are considered to be four types of spreads:
- Yield spread - this type of spread focuses on the difference between yields on divergant debt instruments of changeable maturities, credit ratings and risk. It is calculated through the deduction of the yield of one instrument from another one.
- Bid-ask spread - this type of spread focuses on the difference between the maximum price at which a buyer is willing to purchase an asset and the minimum price at which a marketer is willing to sell it.
- Option-adjusted spread - this type of spread focuses on the assessment of the spread of a fixed-income security rate and a rate of return considered to be risk-free, which is altered to take into concideration an embedded preference.
- Z-spread - this is the constant spread, which makes the cost of a security the same as the current value of its cash flows, when summed up with the yield, at every point on the spot rate Treasury curve where the cash flow is collected.
The asset-swap spread is an example of the yield spread classification.
Credit Default Swap
The Credit Default Swap also, known as the CDS, consists of an OTC (over-the-counter) transaction between two parties, where the protection of the purchaser, brings in a stream of coupon payment to the marketer's protection, till an earlier state of maturity, or entity default to counterbalance a default contingent fee. Such contracts can be settled by cash, when the buyer's security receives from the marketer's protection the cash amount of par less restoration.
When subtracting the CDS spread and asset-swap spread (also known as ASW) one is left with a so-called CDS-Bond basis. It's purpose is to indicate the relative value of the relation between Credit Default Swap and cash bonds. Once the CDS spread value turns out to be higher than the ASW, the basis is considered to be positive, and therefore means that the Credit Default Swap is considered as more attractive, than the cash bond.
- P. Marina 2014, p.69
- M. Choudhry 2005, p.1
- R. Zhou 2008, p.1-2
- Choudhry M., (2005) Understanding the Z-Spread Learning Curve, September 2005, p.1
- Marina P., (2014)Interest Rate SwapsEconomic Analysis, vol. 47, p. 69
- Zhou R., (2008) Bond Implied CDS Spread and CDS-Bond Basis September 2008, p. 1-2
Author: Marta Marzec