Constant maturity swap is a type of interest rate swap where the rate of interest of any single leg is readjusted in a periodic manner in case of market swap rate but not with the LIBOR (London Interbank Offered Rate) or any other floating reference index rate. In other words, the constant maturity swap allows the purchasers to fix the duration of the received flows on a 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
Last Updated on : 1st July 2013