Why Interest Rate Swaps Quote Floating Spreads Separately
Summary
The document explains why a swap may specify a fixed payment against a floating rate plus a spread, rather than expressing the deal as a lower fixed rate against the benchmark alone. The two forms are equivalent only under assumptions about matching payment frequencies and day-count conventions; differing conventions can make the cash flows unequal.
Keeping the spread on the floating leg can directly match an existing liability, such as a floating-rate loan, and reduce operational mismatches when converting its payments to fixed. A holder of a fixed-coupon bond may likewise swap the coupon stream for a floating benchmark plus a spread. The format can also make comparisons against a floating-rate benchmark more useful for some entities. These are practical explanations rather than a pricing analysis, and the note does not quantify how convention differences affect value.
Key ideas
- A floating spread cannot always be shifted to the fixed leg without changing cash flows.
- Equivalence depends on payment frequency and day-count conventions matching across swap legs.
- Swapping the actual floating liability can help align hedge cash flows with the underlying obligation.
- Benchmark-plus-spread quotes may be more useful for some entities than fixed-rate comparisons.
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Full text
# What are advantages of expressing swaps this way? # What are advantages of expressing swaps this way? On page 420 of Bailey's "The Economics of Financial Markets" textbook there is an example: "For example, suppose that [in a plain vanilla interest rate swap] the company agrees to pay 9.25 per cent and receive LIBOR + 40b.p." Isn't this equivalent to a swap where the company pays 8.85 per cent and receive LIBOR? What are the advantages of expressing the contract this way? ## Answer by Attack68 (score 2) https://quant.stackexchange.com/a/39712 There might be a number of reasons swaps are structured this way. Firstly, you only make the assumption of 40bps on both legs (fixed and floating) being equivalent if the payment frequency is the same, and the day count fraction too. If it isn't, say one is Annual-Fixed and the other Quarterly-Floating then then it will be different. In US and EUR for example both frequency and DCF are normally different. Corporates and asset managers often swap their actual cashflows, so if a corporate has issued a floating rate loan at LIBOR+40 and it wants to convert it to fixed then it is natural to swap the precise floating leg so there are no mismatches in cashflows. This is just operationally efficient. Equivalently an investor who has purchased a bond and receives a fixed coupon of say 3% may indeed swap it with a 3% fixed rate to return LIBOR + X bps. Benchmarking as LIBOR + X is often a very common measure and more meaningful to some entities than others, where the fixed rates may be less of a concern.
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