what is an asset swap 
an asset swap is similar in structure to a plain vanilla swap with the key difference being the underlying of the swap contract rather than regular fixed and floating loan interest rates being swapped fixed and floating assets are being exchanged all swaps are derivative contracts through which two parties exchange financial instruments these instruments can be almost anything but most swaps involve cash flows based on a notional principal amount agreed upon by both parties as the name suggests asset swaps involve an actual asset exchange instead of just cash flows swaps do not trade on exchanges and retail investors do not generally engage in swaps rather swaps are over the counter otc contracts between businesses or financial institutions understanding an asset swapasset swaps can be used to overlay the fixed interest rates of bond coupons with floating rates in that sense they are used to transform cash flow characteristics of underlying assets and transforming them to hedge the asset s risks whether related to currency credit and or interest rates typically an asset swap involves transactions in which the investor acquires a bond position and then enters into an interest rate swap with the bank that sold them the bond the investor pays fixed and receives floating this transforms the fixed coupon of the bond into a libor based floating coupon it is widely used by banks to convert their long term fixed rate assets to a floating rate in order to match their short term liabilities depositor accounts another use is to insure against loss due to credit risk such as default or bankruptcy of the bond s issuer here the swap buyer is also buying protection some asset swaps can be quite involved such as asset swapped convertible option transactions ascot used to separate fixed income and equity components of a bond offering the process of an asset swapwhether the swap is to hedge interest rate risk or default risk there are two separate trades that occur first the swap buyer purchases a bond from the swap seller in return for a full price of par plus accrued interest called the dirty price next the two parties create a contract where the buyer agrees to pay fixed coupons to the swap seller equal to the fixed rate coupons received from the bond in return the swap buyer receives variable rate payments of libor plus or minus an agreed upon fixed spread the maturity of this swap is the same as the maturity of the asset the mechanics are the same for the swap buyer wishing to hedge default or some other event risk here the swap buyer is essentially buying protection and the swap seller is also selling that protection as before the swap seller protection seller will agree to pay the swap buyer protection buyer libor plus or minus a spread in return for the cash flows of the risky bond the bond itself does not change hands in the event of default the swap buyer will continue to receive libor plus or minus the spread from the swap seller in this way the swap buyer has transformed its original risk profile by changing both its interest rate and credit risk exposure due to recent scandals and questions around its validity as a benchmark rate libor is being phased out according to the federal reserve and regulators in the u k libor will be phased out by june 30 2023 and will be replaced by the secured overnight financing rate sofr as part of this phase out libor one week and two month usd libor rates will no longer be published after dec 31 2021 1