asset swap

[shanlane]

Hello,

There seem to be multiple definitins of exactly what an asset swap is. Hull defines it one way, Culp defines it another. Online there are multiple definitions ans many contradict each other.

Does the test use a specific definition of exactly what an asset swap is and the mechanics of how it works? For example, many definitions just make it sound like an interest rate swap (fixed for floating, where the fixed is the coupon on a bond or some other reference asset), while Hull (in the credit risk chapter) almost makes it seem like a total return swap:

If a bond is priced at 95, then the owner of the bond pays the coupons plus 5% of notional at the outset while receiving LIBOR plus some spread.

Thanks!

Shannon

 

[David Harper CFA FRM]

Hi Shannon,

In the assigned Culp Chapter 16 (securitization), you see a definition of asset swap (page 364) that has, to my knowledge, always applied at least to the FRM. You're right, and I did not notice this until now, that "asset swap" has currently fallen through the cracks (no AIMs explicitly). For years, Meissner was assigned and we had a maybe cleaner typology. But, regardless, these definitions of asset swap are all similar I think:

• seller (dealer) pays LIBOR + spread; in exchange for:
• buyer (asset owner) who pays the fixed-rate coupon a the reference bond (asset), which the buyer owns (i.e., has funded)

i.e., as an interest rate swap (IRS) is unfunded, this is like a funded IRS: the buyer funds a bond, then swaps out the fixed coupons for floating-rate coupons

Difference from TROR (TRS): A total return swap hedges against credit and market risk, but the asset swap only hedges against market risk. In a TROR, the asset owner is hedges (is compensated for) default and even credit deterioration: the asset owner gets paid for the deterioration and price decline due to default. But the asset swap buyer retains the credit risk (Culp p 365: "by subtracting defaulted obligations from the notional, the swap dealer is only receiving interest and paying back LIBOR on equivalent on LIVE bonds."). Thanks,