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?


2 Answers 2


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 -

  1. The bond's coupon may be higher than a risk-free bond (reflecting credit risk when the bond was issued)
  2. 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.


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.

  • $\begingroup$ Sorry, my exchange at the beginning is for market price of bond and par value of bond, could you clarify what are exchanged in par-par asset swap spread and market-value asset swap spread? $\endgroup$
    – A.Oreo
    Oct 11, 2017 at 5:49
  • $\begingroup$ Hi @A.Oreo. I'm not 100% sure about the structure you have in mind, but a typical par/par asset swap goes like this: At Time 1, you get a repo loan of 100 + initiate a swap with a NPV of $P + AI - 100$. The total proceeds received ($P+AI-100+100=P+AI$) is just enough to buy the bond, so total net proceeds upfront is zero. Then periodically, you receive the coupon from the bond and pays the same coupon amount to the swap desk, while receiving $\text{LIBOR} + s$ from the swap desk. At maturity, the swap matures, the bond pays back 100, which you then use to retire the repo loan (100). $\endgroup$
    – Helin
    Oct 11, 2017 at 6:57

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