Basis swap
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A basis swap is an interest rate swap which involves the exchange of two floating rate financial instruments. A floating-floating interest rate swap under which the floating rate payments is referenced to different bases.
[edit] Usage of basis swaps for hedging
Basis risk occurs for positions that have at least one paying and one receiving stream of cash flows that are driven by different factors and the correlation between those factors are less than one. Entering into a Basis Swap may offset the effect of gains or losses resulting from changes in the basis, thus reducing basis risk. Trading in PRDC usually involves using Basis Swaps to hedge against basis risk between JPY LIBOR and EUR LIBOR yields. Hence basis swaps can be used to hedge. So this is what swap means.
- against exposure to currency fluctuations (for example, 1 mo USD LIBOR for 1 mo GBP LIBOR)
- against one index in the favor of another (for example, 1 mo USD T-bill for 1 mo USD LIBOR)
- different points on a yield curve (for example, 1 mo USD LIBOR for 6 mo USD LI
[edit] Basis swaps in energy commodities
In energy markets, a basis swap is a swap on the price differential for a product and a major index product (e.g. Brent Crude or Henry Hub gas).
[edit] See also
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