Swaps: Constant maturity swaps (CMS) and constant maturity
Treasury (CMT) swaps
A Constant Maturity Swap (CMS) swap is a swap where one of the legs pays
(respectively receives) a swap rate of a fixed maturity, while the other leg
receives (respectively pays) fixed (most common) or floating. A CMT swap is
very similar to a CMS swap, with the exception that one pays the par yield of
a Treasury bond, note or bill instead of the swap rate.
More generally, one calls Constant Maturity Swap and Constant Maturity
Treasury derivatives, derivatives that refer to a swap rate of a given maturity
or a pay yield of a bond, note or bill with a constant maturity. Since most
likely, treasury issued on the market will not exactly match the maturity of the
reference rate, one needs to interpolate market yield. (rates published by the
British Banker Association in Europe and by the Federal Reserve Bank of
New York)
MARKETING OF THESE PRODUCTS
CMT and CMS swaps provide a flexible and market efficient access to long
dated interest rates. On the liability side, CMS and CMT swaps offer the ability
to hedge long-dated positions. Great clients have been life insurers as they
are heavily indebted in long dated payment obligations. Generous insurance
policies need to be hedged against the sharp rise of the back end of the
interest rate curve. Typical trade is a swap where they received the swap rate.
On the asset side, corporate and other financial institutions have heavily
invested in CMS market to enjoy yield enhancement and diversified funding.
In a very steep curve environment, swaps paying CMS look very attractive to
clients that think that the swap rates would not go as high as the market (and
the forward curve) is pricing. Alternatively, in a flat yield curve environment,
swaps receiving CMS look very attractive to market participants thinking that
swap rates would rise in the futures as a consequence of the steepening of
the curve. In a swap where one pays Libor plus a spread versus receiving
CMS 1