Basis trading is a form of fixed-income arbitrage that seeks to benefit from a change in the spread between a spot bond price and an adjusted futures price.
Recall that yield curves (also known as the term structure of interest rates) plot debt maturities (the independent variable) against interest rates (the dependent variable).
Though there are several types of interest rate swaps (IRS), the most familiar type is known as fixed-for-floating. A notional amount of principle is used to calculate periodic fixed and floating interest payments. One of the counterparties receives fixed interest payments and pays out floating-rate interest to the other counterparty, who reciprocates by paying fixed and receiving floating. The floating rate can be pegged to three-month the U.S. Treasury bills, London Interbank Offer Rate (LIBOR), or any other well-established rate index. Continue reading “Termination of Interest Rate Swaps” »