Asset Swap

An asset swap is a combination of a defaultable bond with a fixed-for-floating interest rate swap that swaps the coupon of the bond into the cash flows of LIBOR plus a spread. In the case of a cross currency asset swap, the principal cash flow may also be swapped. In a typical asset swap, a dealer buys a bond from a customer at the market price and sells to the customer a floating rate note at par. The dealer then enters into a fixed-for-floating swap with another counterparty to offset the floating rate obligation and the bond cash flows. For a premium bond, the dealer pays the customer the difference of the bond price and its par. For a discount bond, the customer pays the dealer the difference of the par and the bond price. In the swap with the counterparty, the dealer pays a fixed bond coupon and receives LIBOR + a spread. The spread can be determined from the cash that the dealer pays/receives and from the difference of the bond coupon and the par swap rate. When the bond redemption value is used for exchange of principal at maturity, the present value of the difference between the bond redemption value and its par value also contributes to the spread.


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