A trade that consists of taking a position in a bond and an opposite position in a swap for the purpose of capitalizing on potential swap spread movements. The empirical evidence suggests that swap spreads, most of the time, vary within a specific range. At times of extreme movements, investor can execute trades whereby they could capture the swap spread (asset swap spread). The swap spread for a bond (i.e., in an asset swap where the underlying asset is a bond), is typically measured as follows:
Swap spread= swap implied yield – market yield
The swap implied price is the present value of the cashflows of a bond discounted using the swap zero curve. This price is used to derive the bond’s swap curve implied yield. Investors can compare swap spreads of a specific market with statistical data (such as swap standard deviations, highs, lows, means, etc) in order to establish bond-swap trades.
