Constant maturity swap
Encyclopedia
A constant maturity swap, also known as a CMS, is a swap
that allows the purchaser to fix the duration
of received flows on a swap.
The floating leg of an interest rate swap typically resets against a published index. The floating leg of a constant maturity swap fixes against a point on the swap curve on a periodic basis.
A constant maturity swap is an interest rate swap where the interest rate on one leg is reset periodically, but with reference to a market swap rate rather than LIBOR. The other leg of the swap is generally LIBOR, but may be a fixed rate or potentially another constant maturity rate. Constant maturity swaps can either be single currency or cross currency swaps. Therefore, the prime factor for a constant maturity swap is the shape of the forward implied yield curves. A single currency constant maturity swap versus LIBOR is similar to a series of differential interest rate fixes (or "DIRF") in the same way that an interest rate swap is similar to a series of forward rate agreements
. Valuation of constant maturity swaps depend on volatilities of different forward rates and therefore requires a stochastic yield curve model or some approximated methodology like a convexity adjustment, see for example Brigo and Mercurio (2001).
Swap (finance)
In finance, a swap is a derivative in which counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved...
that allows the purchaser to fix the duration
Bond duration
In finance, the duration of a financial asset that consists of fixed cash flows, for example a bond, is the weighted average of the times until those fixed cash flows are received....
of received flows on a swap.
The floating leg of an interest rate swap typically resets against a published index. The floating leg of a constant maturity swap fixes against a point on the swap curve on a periodic basis.
A constant maturity swap is an interest rate swap where the interest rate on one leg is reset periodically, but with reference to a market swap rate rather than LIBOR. The other leg of the swap is generally LIBOR, but may be a fixed rate or potentially another constant maturity rate. Constant maturity swaps can either be single currency or cross currency swaps. Therefore, the prime factor for a constant maturity swap is the shape of the forward implied yield curves. A single currency constant maturity swap versus LIBOR is similar to a series of differential interest rate fixes (or "DIRF") in the same way that an interest rate swap is similar to a series of forward rate agreements
Forward rate agreement
In finance, a forward rate agreement is a forward contract, an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used...
. Valuation of constant maturity swaps depend on volatilities of different forward rates and therefore requires a stochastic yield curve model or some approximated methodology like a convexity adjustment, see for example Brigo and Mercurio (2001).