Hedging and Relative Value Strategies · Swaps Trading Guide

Swap spread trades compare a swap rate with a government bond yield. Carry and roll down describe conditional components of performance, not guaranteed income.

Specify the spread convention

A common swap spread measure is the fixed swap rate minus a comparable government bond yield. A 4.2% swap rate and a 4% bond yield give a positive 20 basis point spread. Comparable maturity does not mean identical cash flows, credit structure or liquidity. Quote conventions and reference securities must be consistent.

Build the actual position

One structure buys a government bond and pays fixed on a swap, with sensitivities matched to reduce a parallel rate exposure. It can benefit from a widening swap spread under simplified assumptions. Reversing the directions changes the exposure. Bond financing, repo availability and execution prices are part of the trade, not optional details.

Separate carry from market movement

Carry describes the passage of time contribution under stated assumptions, including coupon, floating payments and financing. Roll down describes the effect of aging along an assumed curve. These calculations depend on the scenario used. A changing curve or financing rate can overwhelm the projected benefit.

Avoid treating a negative spread as free money

Government bond supply, demand, balance sheet costs and market structure can sustain negative spreads. A trade can also retain basis, liquidity and funding risk after DV01 matching. Evaluate the package under spread widening, narrowing, funding shocks and a forced exit.

Try it yourself

A swap rate is 3.75% and the reference government yield is 3.90%. What is the swap spread under the convention used here?

Show the worked answer

The spread is negative 15 basis points. Its sign alone does not establish an arbitrage or a suitable trade.

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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