View source for Finance:Basis swap

A '''basis swap''' is an [[Finance:Interest rate swap|interest rate swap]] which involves the exchange of two floating rate [[Finance:Financial instrument|financial instrument]]s.  A basis swap functions as a floating-floating interest rate swap under which the floating rate payments are referenced to different bases.<ref>[https://www.omg.org/spec/EDMC-FIBO/About-EDMC-FIBO/ Financial Industry Business Ontology Version 2], Annex D: Derivatives, EDM Council, Inc., Object Management Group, Inc., 2019</ref><ref>[https://www.bloomberg.com/news/articles/2017-06-30/explaining-swaps-or-how-to-hedge-currencies-quicktake-q-a Explaining Swaps, or How to Hedge Currencies: QuickTake Q&A] Masaki Kondo, Bloomberg Quicktake, 2017</ref>
The existence of a basis arises from demand and supply imbalances and where, for example, a basis is due for a borrower seeking dollars, this is indicative of a synthetic dollar interest rate in the FX market pricing higher than the direct dollar interest rate. The existence of the basis is a violation of the covered interest rate parity (CIP) condition.<ref>{{Cite journal |last=Henide |first=Karim |date=2022-03-10 |title=Cross-currency credit spreads: harvesting the idiosyncratic basis as a source of ARP |journal=Journal of Derivatives and Quantitative Studies: 선물연구 |volume=30 |issue=2 |pages=74–88 |language=en |doi=10.1108/JDQS-10-2021-0026 |issn=1229-988X|doi-access=free }}</ref>

==Usage of basis swaps for hedging==
[[Finance:Basis risk|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|correlation]] between those factors is 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.

# 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 [[Finance:Yield curve|yield curve]] (for example, 1 mo USD LIBOR for 6 mo USD LIBOR)

==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).

==See also==
*[[Finance:Interest rate swap|Interest rate swap]]
*[[Finance:Basis trading|Basis trading]]

==References==
{{Reflist}}

{{Derivatives market}}

[[Category:Swaps (finance)]]
[[Category:Derivatives (finance)]]
[[Category:Capital budgeting]]


{{Sourceattribution|Basis swap}}