Par-Par Asset Swaps: Funding Bond Premiums and Receiving Floating Returns
Summary
A par-par asset swap converts a bond investment into a floating-rate exposure while keeping the swap notional at par. The investor buys the bond at its dirty price, funds 100 of the purchase cost directly or through repo, and uses an asset swap to handle the difference between the bond cost and par. The bond’s coupon is paid to the dealer through the swap, while the investor receives floating interest plus an agreed spread on par notional; the bond principal arrives at maturity.
The examples explain that if a bond costs 99, the investor can pay an additional 1 upfront through the swap so the combined initial outlay is 100. The swap spread is set to fit the chosen initial cash flow. The description is schematic: actual terms can vary, and it does not derive the spread or address valuation conventions, accrued interest, collateral, or credit and funding risks.
Key ideas
- A par-par asset swap uses par value as the swap notional while the bond may trade away from par.
- The investor exchanges the bond’s fixed coupon payments for floating payments plus an asset swap spread.
- The initial cash flow can account for the difference between the bond’s dirty price and par.
- Repo financing may be used to fund the par amount paid at inception.
- The swap spread adjusts to the agreed initial value and transaction structure.
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Full text
# Par par asset swap mechanics # Par par asset swap mechanics Can a market practitioner explain how par par asset swaps work? I understand the swap fixed leg has the same details as the bond i.e. the fixed rate is equal to the bond coupon rate. The way I look at it: the notional of the swap is the par value of the bond, otherwise fixed payments wouldn't match and the investor wants exposure to 100pct of the principal, but I don't understand why the Pv of the swap should be equal to 100-dirty price. There is something that doesn’t click in the way I look at it. Maybe a practical example would help... the investor buys the bond from the issuer at price 99 then wants to enter into par par swap, what's the rationale behind the swap pricing? ## Answer by Helin (score 4) https://quant.stackexchange.com/a/53679 Conceptually, a par/par asset swap may work as follows (details can always be customized): - At trade inception, you buy a bond priced at $P + AI$. You pay 100 out of pocket (or via a repo). The residual amount, $P + AI - 100$, is obtained with a swap dealer as an asset swap. - After the trade has been initiated, the coupon payments received from the bond are then sent to the swap dealer as the fixed payments on the swap. Meanwhile, you receive a floating payment equal to LIBOR plus a fixed spread on a notional amount of 100. This spread is the pre-determined par/par asset swap spread. - Finally, on the maturity date, you receive the principal payment from the bond. A simple schematic of the cash flows is shown below. If you introduce a repo dealer into the equation (so as to finance the initial 100), then the cash flow structure looks as follows: Note that the initial PV of the asset swap can be anything you want. If it's not $P + AI - 100$, the asset swap spread $s$ will simply be adjusted accordingly. ## Answer by dm63 (score 1) https://quant.stackexchange.com/a/53674 The investor wants to spend 100 on an investment and then receive a floating coupon equal to Libor + some spread. So, investor purchases a bond with price 99 and then does a swap where they pay an extra 1 upfront (thus, total payment =100) , then pays the bond coupon and receives Libor + some spread. Those are the mechanics.
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