Constant Maturity Swap
Constant maturity swap is also known as CMS. The Constant Maturity Swaps may be of two types - Single Currency Swaps or Cross Currency Swaps.The primary difference between interest rate swaps and constant maturity swaps is that the floating leg of the former typically resets against a published index while the floating leg of the latter fixes against a particular point on the swap curve on a periodic basis.
For example, if a customer believes that the difference between three month LIBOR rate will fall relative to the two year swap rate for a particular currency, he will buy a CMS by paying the three month LIBOR rate and will receive the two year swap rate.
The Constant Maturity Swap may be ideal product for two types of users:
- Investors or corporations attempting to take a view in the yield curve while seeking the flexibility that the Constant Maturity Swap will provide over the differential interest rate fix (DIRF)
- Investors or corporations who are seeking to maintain a constant liability duration or constant asset.
The advantages of Constant Maturity Swap are:
- It maintains a constant duration
- It is not subject to the "point in time" as with DIRF
- The user can determine "constant maturity" as any point on the yield curve
- It can be booked the same way as Interest Rate Swap
The disadvantages of Constant Maturity Swap are:
- It requires ISDA documentation
- It suffers from the potential of unlimited loss
More Information Related to Finance Theory
Last Updated on : 1st July 2013