I am a bit confused when it comes to asset swap spreads of fixed rate bonds vs the same issuers floating rate bonds of the same maturity and issued at the same time. Should these not be comparable (if not exactly the same)? My senior tells me that that is not exactly the case, and that it depends on whether you can "monetize the spread". I do not understand what that means.
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3 Answers
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Let me add that in my experience, floating-rate bonds are less liquid than fixed coupon bonds, particularly in emerging markets and also particularly for corporates. As user42108 pointed out, it might not be possible to borrow the floating rate bond (so that you cannot short the asset swap).
Also, if the bid-ask spread on the floating rate bond is large (quite likely, at least larger than the fixed-rate bond), the Asset Swap spread is a "fictional number" in that it is based on the "mid" price for the floating rate bond, but the bid-offer spread on the floater is so far from the mid that the Asset Swap spread itself becomes too wide to trade.
answered Oct 12, 2020 at 13:24
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"it depends on whether you can "monetize the spread""
Presumably means whether you can trade the spread and make (or lose) money by doing so. It's possible there are "limits to arbitrage" - most likely no borrow - that prevent trading the spread. Really, the correct answer is to ask your senior...
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Bond valuation is often assumed to be dependent solely on the 'credit spread'.
But the primary driver of securities prices is supply and demand, and this can materialise in many different ways. Let me give you a list and short description of factors that might create specific supply/demand factors over other bonds of potentially perceived identical credit.
- On the run: liquidity is usually better.
- Futures CTD: trading conditions are usually better.
- Free float / Issue size: greater free float usually lead to better trading conditions.
- Bond is special on repo: financing is less certain might created volatility.
- Bond has a high coupon: this usually creates a bond with a lower risk/price ratio which can be useful for funds without much discretionary in terms of maturity holdings to artificially reduce or extend risk.
- Bond is strippable on a particular coupon series, e.g. mar/sep vs jun/dec.
- Bond has covenants or collective action clause (CAC).
- Whether the bond is fixed or floating in a market where investors have a demand preference.
- Probably many others .. feel free to edit my answer..
