How Par-Par Asset Swaps Reflect Bond Credit Value
Summary
The document explains why a common asset swap exchanges the bond’s face amount rather than its market price at inception, and how that convention affects the spread. It frames the asset swap spread as a relative-value measure built from the bond’s price difference from par and a swap exchanging the bond coupon against a floating rate plus spread.
The accepted explanation says the bond’s coupon can reflect its credit quality at issuance, while a price away from par captures later changes in credit perception. Using face value in the initial capital exchange allows the spread to reflect both effects and helps compare related bonds. A second answer distinguishes par-par spreads from proceeds or market-value spreads: the initial exchange amount can be negotiated, but the spread must be recalculated to match it. The discussion presents a conceptual comparison tool, not a complete valuation model, and does not establish a direct formula linking asset swap spreads to CDS spreads.
Key ideas
- An asset swap spread can serve as a relative-value indicator for bonds.
- The spread reflects both the bond coupon and its price deviation from par.
- A par-par asset swap exchanges face value at inception and applies a corresponding floating-leg spread.
- Exchanging market proceeds instead requires recalculating the spread and produces a different convention.
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Full text
# Why do we swap the bond value and par value at the beginning in the Asset Swap
# Why do we swap the bond value and par value at the beginning in the Asset Swap
I may asked this question before, but I still don't understand. We know that in a asset swap,
A pays the fixed coupon on the bond
B pays LIBOR + Spread
The exchanges take place regardless of whether the bond defaults.
But I don't understand why A and B will swap the bond value and the par value at the beginning(especially for par value, it seems very strange)?
Furthermore, Asset swap is totally a different thing from CDS, but what's the relation between asset swap spread and CDS spread?
## Answer by Chris Taylor (score 4, accepted)
https://quant.stackexchange.com/a/36380
Rather than thinking of an asset swap as a traded instrument, it can be useful to think of the asset swap spread as a relative value indicator. The asset swap PV has two parts, the bond part (valued at $100 - P$) and the swap, which pays the bond's coupon on the fixed leg, and ${\rm LIBOR} + s$ on the floating leg.
The spread $s$ accounts for two properties of the bond that make it distinct from a risk-free bond trading at par -
- The bond's coupon may be higher than a risk-free bond (reflecting credit risk when the bond was issued)
- The bond may not trade at par (reflecting changes in credit risk since the bond was issued)
These components together reflect the current credit-worthiness of the bond. In order for the asset swap spread to correctly reflect the second component, it is necessary that in the initial exchange of bond for capital, the capital is $100 i.e. the face value of the bond, not its market value.
If the capital exchanged was the market value of the bond, the asset swap spread would only reflect the coupon of the bond, which isn't a good indicator of its current credit risk, and would render the asset swap spread useless as a tool for comparing relative value of two related bonds.
## Answer by Helin (score 2)
https://quant.stackexchange.com/a/36379
You don't have to. You can exchange either the par amount, market price (clean or dirty), or any other value, and you can exchange at the beginning of the trade or at maturity. These are all fully negotiable.
When you swap the par value, the spread applied to LIBOR is called the "par-par asset swap spread." However, you could also exchange the market price of the bond, in which case you'd apply a different spread to LIBOR and this spread is known as the "proceeds asset swap spread" or "market-value asset swap spread." As said, you can exchange any value you want – you just need to recalculate the spread accordingly. It's just that par/par or proceeds are the most common ones.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.