The swap factor therefore for a Constant Maturity Swap is the shape of the forward implied yield curves. An investor believes that this spread will narrow substantially at some time over the next 2 years.
In this instance the investor is unsure as to when the expected flattening will occur, but believes that the differential between 3yr swap and LIBOR now bp will average 50bp over the next 2 years. In order to take advantage of this view, the investor can use the Constant Maturity Swap. They can enter the following transaction for 2 years: Investor Receives: GBP 3yr Swap mid rate less bp semi annually Each six months, if the 3yr Swap rate is less than bp, the investor will receive a net positive cashflow, and if the differential is greater than bp, pay a net cashflow.
As the current spread is bp, the investor will be required to pay 45bp for the first 6 months. It is clear that is the investor is correct and the manny vegas porn does average 50bp over the two years, this will result in mature net flow of 55bp to the investor. The advantage is that the timing of the narrowing within the 2 years mature immaterial, as long as the differential averages less than bp, the investor "wins".
A Swedish company has recently embraced swap concept of duration and is keen to manage the duration of its debt portfolio. In the past, the company has used the Interest Rate Swap market to convert LIBOR based funding into fixed rate and as swap transactions mature has sought to replace them with new 3, 5 and 7yr swaps.