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Muni Swap


A short form for municipal swap; an interest rate swap in which one counterparty (an investor) exchanges a municipal index yield for a percentage of a floating rate (3-month LIBOR) or a fixed rate. The other counterparty to this swap is typically a market maker. Municipal swaps provides a municipal entity with access to more favorable returns in the taxable market without selling municipal bonds.

In a swap involving a floating interest rate (identified as a municipal basis swap), the floating rate percentage is typically set and reset according to market conditions, and therefore fluctuating over time. However, at settlement this percentage is set and remains constant for the whole term of the swap. If the interest leg is based on a fixed rate, the swap is called a municipal fixed rate swap. This swap entails an investor to receive fixed and pay a municipal index yield. In the same token, the fixed rate is defined by market conditions, and changes over time. However, it fluctuates, but remains constant as a percentage of the fixed rate swap for 3-month LIBOR. That means the percentage is fixed as it helps keep abreast with fluctuating 3-month LIBOR. At settlement, the fixed rate is set and remains unchanged till maturity date.

The main users of municipal swaps are municipalities with tax-exempt liabilities, on the one hand, and holders of municipal bonds. An investor expecting municipal index yields are going to fall with respect to LIBOR would gain from the positive carry (both from capital rolldown and ratio fall). Municipal swaps can also be used to bet on the direction of interest rates in the municipal market as well as to hedge exposure to local government debt.



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