An interest rate swap in which one leg is pegged to a floating index, e.g., 3-month LIBOR, while the other leg (the CMS leg) is referenced to a long-term swap rate (CMS spread). However, contrary to a standard CMS swap in which each payout depends on the CMS rate fixing, the CMS spread swap is based on the spread between two underlying indices. More specifically, the spread results from the difference between the yields of two different long-term swap rates as observed on each fixing date. For instance, a CMS spread swap may involve the following two distinct rates: a 10-year swap rate (say 9%) and a 5-year swap rate (say 2%). Thus, the spread on which payment calculation is based will be the difference between the longer term swap rate and the shorter term swap rate:

CMS spread = longer-term swap rate – shorter-term swap rate

CMS spread = 9% – 3% = 6%

Therefore, the spread is 600 basis points per year.

This swap allows the receiver of the CMS leg to take a view on the evolution of the yield curve, and as such make a profit whether a steep yield curve or an inverted yield curve is expected.