Interest Rate Swaps · Swaps Trading Guide

A basis swap exchanges two floating reference rates. It manages the difference between benchmarks rather than fixing the entire interest cost.

Identify both indices

A basis swap might pay one floating index and receive another, with a spread added to one leg. Specify which index carries that spread. Different tenors, secured versus unsecured funding, or distinct calculation conventions can make the two references diverge. Both legs moving with broad rates does not make their difference constant.

Follow the spread convention

Assume a contract receives index A plus 0.15 percentage points and pays index B. If A is 3.4% and B is 3.8%, the net annual rate is negative 0.25 percentage points. On $10 million for a 0.25 accrual fraction, the receiver of A pays $6,250 net. Reversing the spread placement changes the calculation.

Use it for a specific mismatch

An institution receiving income linked to A but owing payments linked to B may use a swap to reduce that basis exposure. The notional, observation method and dates must align with the underlying positions. A broad interest rate hedge might leave this mismatch untouched because it targets overall rate movement rather than the relative benchmark difference.

Stress the relationship

Benchmark differences can widen during funding stress or market disruption. Historical correlation is not a contractual guarantee. Check fallback provisions for each leg and whether both benchmarks would transition in the same way. Report basis sensitivity separately from broad rate sensitivity so a small net duration does not disguise a large relative exposure.

Try it yourself

A swap receives A plus 0.10 percentage points and pays B. A is 4.0%, B is 4.05%, notional is $8 million and the fraction is 0.5. Calculate net cash.

Show the worked answer

The net rate received is 4.10% minus 4.05% = 0.05 percentage points. Net receipt is $8,000,000 × 0.0005 × 0.5 = $2,000.

Further reading

Educational material, not a recommendation to transact. Numerical examples are hypothetical and simplify contract terms. Access, documentation, collateral and regulatory requirements depend on the product, jurisdiction and counterparties.

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